Kohers Inc. is considering a leasing arrangement to finance some manufacturing t
ID: 2668417 • Letter: K
Question
Kohers Inc. is considering a leasing arrangement to finance some manufacturing tools that it needs for the next 3 years. The tools will be obsolete and worthless after 3 years. The firm will depreciate the cost of the tools on a straight-line basis over their 3-year life. It can borrow $4,800,000, the purchase price, at 10% and buy the tools, or it can make 3 equal end-of-year lease payments of $2,100,000 each and lease them. The loan obtained from the bank is a 3-year simple interest loan, with interest paid at the end of the year. The firm's tax rate is 40%. Annual maintenance costs associated with ownership are estimated at $240,000, but this cost would be borne by the lessor if it leases. What is the net advantage to leasing (NAL), in thousands? (Suggestion: Delete 3 zeros from dollars and work in thousands.)Explanation / Answer
Annual depreciation = $4,800,000/3 = $1,600,000.
(In thousands) Year
0 1 2 3
I. Cost of owning
Net purchase price ($4,800)
Maintenance cost ($ 240) ($ 240) ($ 240)
Maintenance tax savings
(Line 2 ´ 0.4) 96 96 96
Depreciation 1,600 1,600 1,600
Depreciation tax savings
(Line 4 ´ 0.4) 640 640 640
Net cash flow ($4,800) 496 496 496
PV cost of owning
(6%) ($3,474.2)
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II. Cost of leasing
8) Lease payment ($2,100) ($2,100) ($2,100)
9) Lease pmt tax savings 840 840 840
10) Net cash flow $ 0 ($1,260) ($1,260) ($1,260)
11) PV cost of leasing
(@6%) ($3,368.0)
III. Cost comparison
Net advantage to leasing:
NAL = PV cost of owning - PV cost of leasing
= $3,474.2 - $3,368.0 = $106.2.
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Inputs: CF0 = -4800; CF1 = 496; Nj = 3; I/YR = 6.
Output: NPV = -$3,474.2.
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Leasing: Inputs: CF0 = 0; CF1 = -1260; Nj = 3; I/YR = 6.
Output: NPV = -$3,368.0.
================
NAL = $3,474.2 - $3,368.0 = $106.2.
, NAL = $106.2 ´ 1,000 = $106,200.
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