The SALT Company is considering the acquisition of a new processor used in its o

Question

The SALT Company is considering the acquisition of a new processor used in its operation. The processor has an installed cost of $47,000 and is expected to have a useful life of 5 years. If purchased, the firm would borrow the entire $47,000 at an interest rate of 6%. The processor would be depreciated over a 5 year ACRS life to a zero book value, but it is estimated that it could be sold for $8,000 after 5 years. A capital budgeting analysis indicates that purchase of the processor has a positive NPV. Alternatively, SALT Company can lease the processor for the 5 year period for an annual lease payment of $12,500. If the processor is leased, annual operating expenses of $2,600 will be paid by the lessor. If the equipment is purchased, the firm will incur this expense. SALT Company's cost of capital is 12% and its marginal tax rate is 35%.

A) If S Company borrows to purchase the processor, what is the annual loan payment?

B) If S Company borrows to purchase the processor, the interest paid on the loan in year 2 is:

C) If S Company borrows to purchase the processor, total tax deductible expenses for year 3 are:

D) If S Company borrows to purchase the processor, the net cost of owning for year 3 is:

E) The present value of the costs of owning is:

F) The present value of the cost of leasing the processor is:

Explanation / Answer

A Loan balance Int. on beg.bal. Principal repaid Principal balance Year 1 47000 2820 9400 37600 2 37600 2256 9400 28200 3 28200 1692 9400 18800 4 18800 1128 9400 9400 5 9400 564 9400 0 Annual loan payment= $ 9400 ACRS Depreciation Year 1 15 7050 2 22 10340 3 21 9870 4 21 9870 5 21 9870 100 47000 B Interest paid on the loan in Year 2 = $ 2256 C Total tax deductible expenses for year 3 are: Interest on loan 1692 Depreciation47000*22% 10340 Annual operating exp. 2600 Total 14632 D Net cost of owning for year 3 is Expenses as above 14632 Loan repayment 9400 24032 E) The present value of the costs of owning is: Year 0 1 2 3 4 5 Initial cost 47000 Loan Interest 2820 2256 1692 1128 564 Annual opg. Exp 2600 2600 2600 2600 2600 Depreciation 7050 10340 9870 9870 9870 Sale proceeds -8000 Total outflow 47000 12470 15196 14162 13598 5034 Less: Tax savings @ 35% 4364.5 5319 4957 4759 1762 Net Outflow 47000 8105.5 9877 9205 8839 3272 PV F @ 12% 1 0.89286 0.79719 0.71178 0.63552 0.56743 PV @ 12% 47000 7237.077 7874.165 6552.148 5617.171 1856.688 PV of costs 76137.25 F) The present value of the cost of leasing the processor is: Year 0 1 2 3 4 5 Annual lease rental 12500 12500 12500 12500 12500 Less: Tax savings @ 35% 4375 4375 4375 4375 4375 Net cost 8125 8125 8125 8125 8125 PV F @ 12% 0.89286 0.79719 0.71178 0.63552 0.56743 PV @ 12% 7254.488 6477.169 5783.213 5163.6 4610.369 PV of costs 29288.84

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