The S Company is considering the acquisition of a new processor used in its oper
ID: 2477882 • Letter: T
Question
The S Company is considering the acquisition of a new processor used in its operation. The processor has an installed cost of $55,000 and is expected to have a useful life of 5 years. If purchased, the firm would borrow the entire $55,000 at an interest rate of 9%. 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 $7,000 after 5 years. A capital budgeting analysis indicates that purchase of the processor has a positive NPV. Alternatively, S Company can lease the processor for the 5 year period for an annual lease payment of $11,500. If the processor is leased, annual operating expenses of $2,900 will be paid by the lessor. If the equipment is purchased, the firm will incur this expense. S Company's cost of capital is 12% and its marginal tax rate is 35%.
If S Company borrows to purchase the processor, total tax deductible expenses for year 3 are:
a. $20,305
b. $16,383
c. $17,671
d. $22,144
If S Company borrows to purchase the processor, the net cost of owning for year 3 is:
a. $10,855
b. $9,474
c. $7,956
d. $12,076
The present value of the costs of owning is:
a. $49,056
b. $48,254
c. $45,545
d. $46,794
If S Company borrows to purchase the processor, total tax deductible expenses for year 3 are:
a. $20,305
b. $16,383
c. $17,671
d. $22,144
If S Company borrows to purchase the processor, the net cost of owning for year 3 is:
a. $10,855
b. $9,474
c. $7,956
d. $12,076
The present value of the costs of owning is:
a. $49,056
b. $48,254
c. $45,545
d. $46,794
The PV of the cost of leasing the is?
The present value of the cost of leasing the processor is:
a. $34,317
b. $34,832
c. $33,776
d. $34,465
Explanation / Answer
Purchase the asset:-
Annual Operating expense = $2900
Annual Interest Expense = 55,000*9%
= $4950
Annual Depreciation = 55,000/5
=$11,000
Principal Repayment at the end of 5th year = $55,000
Net Sales proceeds from sale of asset = 7000 - 7000*0.35
= $4550
Annual Cash Outflow under purchase alternative (Year-1 to year-4) = 4950*0.65 + 2900*0.65 - 11,000*0.35
= $1253
Net Outflow in Year - 5 = 1253 + 55,000 - 4550
= $51,703
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Lease Alternative
Annula Lease payments = $11,500
Net Annual Cash Outflow = 11,500*0.65
= $7475
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1)If S Company borrows to purchase the processor, total tax deductible expenses for year 3 are:
Ans = 4950 + 2900 + 11000
= $18850
3)The present value of the costs of owning is = 1253*PVIFA(12%,5) + 51,703*PVIF(12%,5)
= 1253*3.6048 + 51,703*0.5674
=$33,853
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4)The present value of the cost of leasing the processor is = 7475*PVIFA(!2%,5)
= 7475*3.6048
= $26946
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