Suppose a company wants to decide whether to lease or purchase an asset. Purchas

Question

Suppose a company wants to decide whether to lease or purchase an asset. Purchase: The capital cost required to purchase the asset is $1,000,000 (at time zero) with a salvage value of $500,000 at the end of the 5th year. The purchased asset can be depreciated based on MACRS 5-year life depreciation with the half year convention (table A-1 at IRS) over six years (from year 0 to year 5). Lease: The asset can be leased for 5 years and annual lease payments (LP) of $250,000 (from year 1 to year 5). The asset would yield the annual revenue of $350,000 for five years (from year 1 to year 5) and operating cost of $60,000 for year 1 to 5. Considering income tax of 35% and minimum ROR of 12%, calculate the ATCF and NPV for both alternatives and conclude which alternative is a better decision.

Explanation / Answer

Alternative 1: Purchase the Asset STATEMENT SHOWING NPV Yr PFV @12% Amount PV Annual Revenue 01-05 3.6047762 350000 -Annual Expense 01-05 3.6047762 60000 depreciation 01-05 3.6047762 200000 [dep each yr 1000000/5yr] PBT 90000 Less: Tax 31500 PAT 58500 Ad: dep                             ` 200000 CFAT 01-05 3.6047762 258500 931834.6 Salvage value (1-tax) 5 0.5674269 175000 99299.7 pV of Cash Inflow 1031134 Less: Cost of Machine 1000000 NPV 31134.35 B. LEASE THE ASSET STATEMENT SHOWING NPV Yr PFV @12% Amount PV Annual Revenue 01-05 3.6047762 350000 -Annual Expense 01-05 3.6047762 60000 Annual Lease Payment 01-05 3.6047762 250000 [dep each yr 1000000/5yr] PBT 40000 Less: Tax 14000 CFAT 01-05 3.6047762 26000 93724.18 NPV 93724.18 Its better to lease the asset as it has higher npv

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.