United Hospital has received a leasing proposal from Leasing, Inc., for a Siemen
ID: 2666147 • Letter: U
Question
United Hospital has received a leasing proposal from Leasing, Inc., for a Siemens cardiaccatheterization unit. The terms are:
• Five-year lease
• Annual payments of $200,000 payable one year in advance
• Payment of property tax estimated to be $23,000 annually
• Renewal at end of year 5 at fair market value
Alternatively, United Hospital can buy the catheterization unit for $725,000. This purchase would require United Hospital to debt-finance this equipment. It anticipates a bank loan with an initial down payment of $125,000 and a three-year term loan at 16 percent with equal principal payments. The residual value of the equipment at year 5 is estimated to be $225,000. The lease is treated as an operating lease. Depreciation is calculated on a straight-line basis. Assuming a discount rate of 14 percent, what financing option should United Hospital select? Assume that there is no reimbursement of capital costs.
Explanation / Answer
In above situation no tax rate has been given therefore the tax shield available on interest and depreciation has been ignored while calculating cash flow in purchase option. Pv under operating lease pv of annuity due = annuity x ((1-1/(1+i)n)/i}+1 = 223000 x ((1-1/(1+.14)4)/.14}+1 = 223000 x 3.9137 = $872758 Bank borrowing amount of installment on 725000-125000= 600000/(1-1/(1+i)n)/i )=600000/(1-1/(1+.16)3)/.16)= 600000/2.24589 = $267155 year cash flow 14% d.f pv 0 125000 1 125000 1 267155 0.877193 234346.5 2 267155 0.769468 205567.1 3 267155 0.674972 180322 4 0 0.59208 0 5 -225000 0.519369 -116858 net present value 628378 Conclusion: As the pv of bank borrowing is less than operating lease therefore purchase option through bank borrowing should be preferred SOURCES: GRAD STUDENT
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