Shoes Ltd manufactures shoes and socks and wants to expand its product line. Management has indicated that a new machine is required to manufacture a new line of brightly coloured socks. To purchase the machine, it has negotiated financing at a favourable before-tax cost of 12% interest per annum, with equal annual end-of-year instalments. Alternatively, the company can enter into a direct financial lease with the manufacturer of the machine, which means that the manufacturer will offer the machine and maintain it for its useful life at a cost of R150 000 per year, paid at the beginning of each year, for four years. The machine costs R500 000 and it is expected that it will require maintenance of R60 000 per year, if bought. It is also expected that the machine can be sold for R100 000 at the end of its useful life of four years. The machine can be depreciated by way of the straight-line method over a period of four years. A tax rate of 28% is applicable. The company has a before-tax cost of debt of 15%.
Required: Determine the net advantage of leasing and advise the company on the option they should
take based on your findings.
