Treadmill Trucking Company is negotiating a lease for five new tractor/trailer r

Question

Treadmill Trucking Company is negotiating a lease for five new tractor/trailer rigs with Leasing International. Treadmill has received its best offer from Betterbilt Trucks for a total price of $1 million. The terms of the lease offered by International Leasing call for a payment of $205,000 at the beginning of each year of the 5-year lease. As an alternative to leasing, the firm can borrow from a large insurance company and buy the trucks. The $1 million would be borrowed on an amortized term loan at a 10 percent interest rate for 5 years. The trucks fall into the MACRS 5-year class and have an expected residual value of $100,000. Maintenance costs would be included in the lease. If the trucks are owned, a maintenance contract would be purchased at the beginning of each year for $10,000 per year. Treadmill plans to buy a new fleet of trucks at the end of the fifth year. Leasing International has a 40 percent federal-plus-state marginal tax rate, while Treadmill Trucking has a total tax rate of 20 percent. Should the firm purchase or lease. Determine the PV for both. Find the NAL

Explanation / Answer

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Treadmill Trucking Company is negotiating a lease for five new tractor/trailer rigs with Leasing International. Treadmill has received its best offer from Betterbilt Trucks for a total price of $900,000. The terms of the lease offered by International Leasing call for a payment of $190,000 at the beginning of each year of the 5-year lease. As an alternative to leasing, the firm can borrow from a large insurance company and buy the trucks. The $900,000 would be borrowed on an amortized term loan at a 10 percent interest rate for 5 years. The trucks fall into the MACRS 5-year class and have an expected residual value of $90,000. Maintenance costs would be included in the lease. If the trucks are owned, a maintenance contract would be purchased at the beginning of each year for $8,000 per year. Treadmill plans to buy a new fleet of trucks at the end of the fifth year. Treadmill Trucking has a total tax rate of 20 percent. Should the firm purchase or lease? Determine the PV of both. Find the NAL.   

Answer

Leasing Y0 Y1 Y2 Y3 Y4 Y5 Lease Payments 0 190000 190000 190000 190000 190000 tax savings on rentals 0 -38000 -38000 -38000 -38000 -38000 Total cash outflows 0 152000 152000 152000 152000 152000 Discounting factor @ 20% 1.000 0.833 0.694 0.579 0.482 0.402 Present values@20% - 126,666.667 105,555.556 87,962.963 73,302.469 61,085.391 Total cost of leasing 454,573.045 Borrowing Maintenance costs 8000 8000 8000 8000 8000 0 Int. savings on maintenance 0 -1600 -1600 -1600 -1600 -1600 assuming tax savings at year end Principal repaymens 0 180000 180000 180000 180000 180000 Int. Exp. Depreciation 0 198000 162000 162000 162000 162000 Savings due to tax on depreciation 0 -39600 -32400 -32400 -32400 -32400 Salvage Value 0 0 0 0 0 -90000 Total cash outflows 8000 344800 316000 316000 316000 218000 Discounting factor @ 20% 1.000 0.833 0.694 0.579 0.482 0.402 Present values@20% 8,000.000 287,333.333 219,444.444 182,870.370 152,391.975 87,609.311 Total cost of borrowing 937,649.434 Net Advantage of leasing 483,076.389

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