The Decision to Lease or Buy at Warf Computers Warf Computershas decided to proceed with the manufacture and distribution of thevirtual keyboard (VK) the company has developed. To undertake thisventure, the company needs to obtain equipment for the productionof the microphone for the keyboard. Because of the requiredsensitivity of the microphone and its small size, the company needsspecialized equipment for production. Nick Warf, the companypresident, has found a vendor for the equipment. Clapton AcousticalEquipment has offered to sell Warf Computers the necessaryequipment at a price of $7.1 million. Because of the rapiddevelopment of new technology, the equipment falls in class 45 witha CCA rate of 45 percent. At the end of four years, the marketvalue of the equipment is expected to be $860,000. Alternatively,the company can lease the equipment from Hendrix Leasing. The leasecontract calls for four annual payments of $1.86 million due at thebeginning of the year. Additionally, Warf Computers must make asecurity deposit of $440,000 that will be returned when the leaseexpires. Warf Computers can issue bonds with a yield of 11 percent,and the company has a marginal tax rate of 35 percent.
Questions
1) Should Warf buy or lease the equipment?
2) Nick mentions to James Hendrix, the president of HendrixLeasing, that although the company will need the equipment for fouryears, he would like a lease contract for two years instead. At theend of the two years, the lease could be renewed. Nick would alsolike to eliminate the security deposit, but he would be willing toincrease the lease payments to $3.0 million for each of the twoyears. When the lease is renewed in two years, Hendrix wouldconsider the increased lease payments in the first two years whencalculating the terms of the renewal. The equipment is expected tohave a market value of $2.1 million in two years. What is the NALof the lease contract under these terms? Why might Nick prefer thislease? What are the potential ethical issues concerning the newlease terms?
