The S Company is considering the acquisition of a new processor used in its oper
ID: 2478038 • 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 $57,000 and is expected to have a useful life of 5 years. If purchased, the firm would borrow the entire $57,000 at an interest rate of 7%. 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 $6,000 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 $2,100 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, what is the annual loan payment?
If S Company borrows to purchase the processor, the interest paid on the loan in year 2 is?
If S Company borrows to purchase the processor, total tax deductible expenses for year 3 are?
If S Company borrows to purchase the processor, the net cost of owning for year 3 is?
The present value of the costs of owning is?
The present value of the cost of leasing the processor is?
Explanation / Answer
Solution :
If S Company borrows to purchase the processor, what is the annual loan payment?
Annula payment = Loan x interest rate/(1-(1+r)^-n)
=57000 * .07 / (1-(1+.07)^-5
=13901.77
Loan schedule
year
opening balance
annual payment
interest@7%
principal
Closing balance
1
57000
13,901.77
3990
9,911.77
47,088.23
2
47,088.23
13,901.77
3296.176129
10,605.59
36,482.64
3
36,482.64
13,901.77
2553.784587
11,347.98
25,134.65
4
25,134.65
13,901.77
1759.425638
12,142.34
12,992.31
5
12,992.31
13,901.77
909.4615615
12,992.31
-
If S Company borrows to purchase the processor, the interest paid on the loan in year 2 is?
interest paid on the loan in year 2 = 3296.18
If S Company borrows to purchase the processor, total tax deductible expenses for year 3 are
Interest
2553.78459
operating expense
2100
depreciation (57000-6000)/5
10200
total
14,853.78
If S Company borrows to purchase the processor, the net cost of owning for year 3 is
Interest
2,553.78
operating expense
2,100.00
depreciation (57000-6000)/5
10,200.00
total
14,853.78
Lease payment
11,500.00
savings in operating expense
- 2,100.00
total cost under lease
9,400.00
net cost of owning
5,453.78
present value of the costs of owning is
year
interest
@7%
operating expense
depreciation
TOTAL
TAX SAVING
NET COST
CASH COST (NET COST-DEP)
DISCOUNT FACTOR@12%
PV
1
3,990.00
2100
10,200.00
16,290.00
5,701.50
10,588.50
388.50
0.892857143
346.88
2
3,296.18
2100
10200
15,596.18
5,458.66
10,137.51
- 62.49
0.797193878
- 49.81
3
2,553.78
2100
10200
14,853.78
5,198.82
9,654.96
- 545.04
0.711780248
- 387.95
4
1,759.43
2100
10200
14,059.43
4,920.80
9,138.63
- 1,061.37
0.635518078
- 674.52
5
909.46
2100
10200
13,209.46
4,623.31
8,586.15
- 1,613.85
0.567426856
- 915.74
PV
- 1,681.15
Add : salvage
3,404.56
- 5,085.71
present value of the cost of leasing the processor is
Lease Paymenty(1-tax) x cumulative discount factor
11500x(.65)x3.604776 = 26945.70
year
opening balance
annual payment
interest@7%
principal
Closing balance
1
57000
13,901.77
3990
9,911.77
47,088.23
2
47,088.23
13,901.77
3296.176129
10,605.59
36,482.64
3
36,482.64
13,901.77
2553.784587
11,347.98
25,134.65
4
25,134.65
13,901.77
1759.425638
12,142.34
12,992.31
5
12,992.31
13,901.77
909.4615615
12,992.31
-
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