Sadik Industries must install $1 million of new machinery in itsTexas plant. It can obtain a 6-year bank loan for 100% of the costat a 14% interest rate with equal payment plans at the end of eachyear. Sadik's tax rate is 34%. The equipment falls in the MACRS3-year class.

Alternatively, a Texas instrument banking firm that represents agroup of investors can arrange a guideline lease calling forpayments of $320,000 at the end of each year for 3 years. Under theproposed lease terms, the Sadik must pay for insurance, propertytaxes, and maintenance.

Sadik must use the equipment if its to continue in business, soit will almost certainly want to acquire the property at the end ofthe lease. If it does, then under the lease terms it can purchasethe machinery at its fair market value at Year 3. The best estimateof this market value is $200,000, but it could be much higher orlower under certain circumstances. If purchased at Year 3, the usedequipment would fall into the MACRS 3-year class. Sadik wouldactually be able to make the purchase on the last day of the year(i.E., slightly before Year 3), so Sadik would get to take thefirst depreciation expense at Year 3 (the remaining depreciationexpenses would be from Year 4 through Year 6). On the time line,Sadik would show the cost of purchasing the used equipment on Year3 and its depreciation expenses starting at Year 3.

To assist management in making the proper lease-versus-buydecisions, you are asked to answer the following questions:

a. What is the net advantage of leasing? Should Sadik take thelease?

Consider the $200,000 estimated residual value. Hoe high couldthe residual value get before the net advantage of leasing falls tozero?

Note: You will have to prepare a debt amortization schedule todetermine the yearly interest costs on the loan Sadik willobtain.