Suppose Clorox can lease a new computer data processing system for $975,000 per year for five years. Alternatively, it can purchase the system for $4.25 million. Assume Clorox has a borrowing cost of 7% and a tax rate of 35%, and the system will be obsolete at the end of five years.
a. If Clorox will depreciate (for tax purposes) the computer equipment on a straight-line basis over the next five years, and if the lease qualifies as a true tax lease, is it better to finance the purchase of the equipment or to lease it?
b. Suppose that if the Clorox Canada division buys the equipment, it will use capital cost allowance for depreciation tax purposes. Specifically, the CCA rate will be 45% and any undercoated capital cost in year 6 will be taken as a terminal loss. Compare leasing with purchase in this case.
