ig Sky Mining Company must install $1.5 million of new machinery in its Nevada m
ID: 2671582 • Letter: I
Question
ig Sky Mining Company must install $1.5 million of new machinery in its Nevada mine. It can obtain a bank loan for 100% of the purchase price, or it can lease the machinery. Assume that the following facts apply: 1. The machinery falls into the MACRS 3-year class. 2. Under either the lease or the purchase, Big Sky must pay for insurance, property taxes, and maintenance. 3. The firm's tax rate is 40%. 4. The loan would have an interest rate of 15%. 5. The lease terms call for $400,000 payments at the end of each of the next 4 years. 6. Assume that the company has no use for the machine beyond the expiration of the lease. The machine has an estimated residual value of $250,000 at the end of the 4th year.What is the NALof the lease?
Explanation / Answer
Cost of ownership
Year
0
1
2
3
4
Loan proceeds
$1,500,000
Purchase cost
$1,500,000
$1,500,000
Interest payments
$195,000
$195,000
$195,000
$195,000
Tax Shield
$78,000
$78,000
$78,000
$78,000
After-tax interest
$117,000
$117,000
$117,000
$117,000
Principal payment
$1,500,000
Tax savings from depreciation
$199,980
$266,700
$88,860
$44,460
$250,000
salvage
$100,000
Taxes on salvage value
($1,500,000)
$82,980
$149,700
($28,140)
PV cost of ownership
($2,370,057.44)
Loan proceeds
$1,500,000
Purchase cost
$1,500,000
Interest payments
$195,000
$195,000
$195,000
$195,000
Tax Shield
$78,000
$78,000
$78,000
$78,000
After-tax interest payment
$117,000
$117,000
$117,000
$117,000
Principal payment
$1,500,000
Annual Cost Savings
$0
$0
$0
$0
Tax on Savings
$0
$0
$0
$0
After-tax Cost Savings
$0
$0
$0
$0
Net cash flow from leasing
($240,000)
($240,000)
($240,000)
($240,000)
PV cost of leasing
($798,462)
PV ownership cost @ 9%
($2,370,057)
PV of leasing @ 9%
($798,462)
Net Advantage to Leasing
$1,571,595
What is the present value cost of ownership? Round your answer to the nearest cent.
$ 869965.97
What is the present value cost of leasing? Round your answer to the nearest cent.
$ 798462
What is the NAL of the lease? Round your answer to the nearest cent.
$ 71503.97
Cost of ownership
Year
0
1
2
3
4
Loan proceeds
$1,500,000
Purchase cost
$1,500,000
$1,500,000
Interest payments
$195,000
$195,000
$195,000
$195,000
Tax Shield
$78,000
$78,000
$78,000
$78,000
After-tax interest
$117,000
$117,000
$117,000
$117,000
Principal payment
$1,500,000
Tax savings from depreciation
$199,980
$266,700
$88,860
$44,460
$250,000
salvage
$100,000
Taxes on salvage value
($1,500,000)
$82,980
$149,700
($28,140)
PV cost of ownership
($2,370,057.44)
Loan proceeds
$1,500,000
Purchase cost
$1,500,000
Interest payments
$195,000
$195,000
$195,000
$195,000
Tax Shield
$78,000
$78,000
$78,000
$78,000
After-tax interest payment
$117,000
$117,000
$117,000
$117,000
Principal payment
$1,500,000
Annual Cost Savings
$0
$0
$0
$0
Tax on Savings
$0
$0
$0
$0
After-tax Cost Savings
$0
$0
$0
$0
Net cash flow from leasing
($240,000)
($240,000)
($240,000)
($240,000)
PV cost of leasing
($798,462)
PV ownership cost @ 9%
($2,370,057)
PV of leasing @ 9%
($798,462)
Net Advantage to Leasing
$1,571,595
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