The decision to lease or buy at Warf Computers questions 1.Should Warf buy or lease the equipment? 2.In the leasing discussion, James informs Nick that th

The decision to lease or buy at Warf Computers questions 1.Should Warf buy or lease the equipment?

2.In the leasing discussion, James informs Nick that the contract could include a purchase option for the equipment at the end of the lease. Hendrix Leasing offers three purchase options:

a.An option to purchase the equipment at the fair market value.

b.An option to purchase the equipment at a fixed price. The price will be negotiated before the lease is signed.

c.An option to purchase the equipment at a price of $250,000.

How would the inclusion of a purchase option affect the value of the lease?

3.James also informs Nick that the lease contract can include a cancellation option. The cancellation option would allow Warf Computers to cancel the lease on any anniversary date of the contract. To cancel the lease, Warf Computers would be required to give 30 days’ notice prior to the anniversary date. How would the inclusion of a cancellation option affect the value of the lease? THE DECISION TO LEASE OR BUY AT WARF
COMPUTERS
Warf Computers has decided to proceed with the manufacture and
distribution of the virtual keyboard (VK) the company has developed. To
undertake this venture, the company needs to obtain equipment for the
production of the microphone for the keyboard. Because of the
required sensitivity of the microphone and its small size, the company needs
specialized equipment for production.
Nick Warf, the company president, has found a vendor for the equipment.
Clapton Acoustical Equipment has offered to sell Warf Computers the
necessary equipment at a price of $6.1 million. Because of the rapid
development of new technology, the equipment falls in the three-year MACRS
depreciation class. At the end of four years, the market value of the equipment
is expected to be $780,000.
Alternatively, the company can lease the equipment from Hendrix Leasing.
The lease contract calls for four annual payments of $1.48 million due at the
beginning of the year. Additionally, Warf Computers must make a security
deposit of $400,000 that will be returned when the lease expires. Warf
Computers can issue bonds with a yield of 11 percent, and the company has a
marginal tax rate of 21 percent.
QUESTIONS
1. Should Warf buy or lease the equipment?
2. In the leasing discussion, James informs Nick that the contract could
include a purchase option for the equipment at the end of the lease.
Hendrix Leasing offers three purchase options:
a. An option to purchase the equipment at the fair market value.
b. An option to purchase the equipment at a fixed price. The price will be
negotiated before the lease is signed.
c. An option to purchase the equipment at a price of $250,000.
How would the inclusion of a purchase option affect the value of the lease?
3. James also informs Nick that the lease contract can include a cancellation
option. The cancellation option would allow Warf Computers to cancel the
lease on any anniversary date of the contract. To cancel the lease, Warf
Computers would be required to give 30 days’ notice prior to the
anniversary date. How would the inclusion of a cancellation option affect
the value of the lease?

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