firm wants the use of a machine that costs $100,000. If the firm purchases the e

Question

firm wants the use of a machine that costs $100,000. If the firm purchases the equipment , it will depreciate the equipment at the rate of $20,000 a year for 4 years, at which time the equipment will have a residual value of $20,000. Maintenance will be $2,500 a year. The firm could lease the equipment for four years for an annual lease payment of $26,342. Currently, the firm is in the 40% income tax bracket.

A.) Determine the firm's cash inflows and outflows from purchasing the equipment and from leasing.

B.) If the firm uses a 14% cost of funds to analyze decisions that involve payments over more than a year, should management lease the equipment to purchase it?

C.) Would your answer differ if the cost of funds were 8%?

Please anser in detail and show all work. thank you for your help.

Explanation / Answer

Hi

Please see below

a. buying

inflows: depreciation, receipts, tax deductible interest, residual value

outflows: maintenance, annual payments, taxes

leasing

inflows: receipts

outfows: maintenance, lease payments, taxes

b. at 14% over 4 years, the annual payments on a $100,000 piece of equipment would be $34,320.48 per year.

(.14+(.14/(((1+.14)^4)-1)))*100,000 =

$34,320.48 * 4 years = $137,281.92 total cost

-$20,000 residual value = $117,281.92 total real cost

/4 years = $29,320.48 annual cost

At 14% it would be cheaper to lease.

Therefore It is cheaper to lease

c. at 8% over 4 years, the annual payments on a $100,000 piece of equipment would be = $30,192.08 per year.

(..08+(.08/(((1+.08)^4)-1)))*100,000 = $30,192.08

$30,192.08 * 4 payments = $120,768.32 total payment

$120,768.32 - 20,000 (residual value) = $100,768.32 total real cost

$100,768.32 / 4 years = $25,192.08 annual real cost

It is cheaper to buy than to lease

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