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As part of its overall plant modernization and cost reduction program, the management ofTeweles Textile Mills has decided to install a new automated weaving loom. In the capitalbudgeting analysis of this equipment, the IRR of the project was found to be 20 percentversus a project required return of 12 percent.The loom has an invoice price of $250,000, including delivery and installation charges. Thefunds needed could be borrowed from the bank through a four-year amortized loan at 10percent interest rate, with payments to be made at the end of each year. In the event thatthe loom is purchased, the manufacturer will contract and service it for a fee of $20,000 peryear at the end of each year. The loom will be depreciated over four years using the straightline method, with a salvage value of $42,500. And Teweles’s tax rate is 40 percent.Apilado Automation Inc., maker of the loom, has offered to lease the loom to Teweles for$70,000 upon delivery and installation (at t=0), plus four additional lease payments of$70,000 to be made at the ends of Years 1 through 4. The lease agreement includesmaintenance and servicing. Teweles plans to build an entirely new plant in four years, so ithas no interest in either leasing or owning the proposed loom for more than that period.(a). Should the loom be leased or purchased? Explain and show your work.
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