Delamont Transport Company (DTC) is evaluating the merits of leasing versus purc
ID: 2709250 • Letter: D
Question
Delamont Transport Company (DTC) is evaluating the merits of leasing versus purchasing a truck with a 4-year life that costs $40,000 and falls into the MACRS 3-year class. If the firm borrows and buys the truck, the loan rate would be 10%, and the loan would be amortized over the truck's 4-year life, so the interest expense for taxes would decline over time. The loan payments would be made at the end of each year. The truck will be used for 4 years, at the end of which time it will be sold at an estimated residual value of $10,000. If DTC buys the truck, it would purchase a maintenance contract that costs $1,000 per year, payable at the end of each year. The lease terms, which include maintenance, call for a $10,000 lease payment (4 payments total) at the beginning of each year. DTC's tax rate is 40%. What is the net advantage to leasing? (Note: Assume MACRS rates for Years 1 to 4 are 0.3333, 0.4445, 0.15, and 0.07.)
$849
$896
$945
$999
$1,047
Explanation / Answer
LIFE OF equipment 4 years
Loan amount = Equipment cost = $40,000
Interest Rate = 10%
Tax rate = 40%
Maintenance cost = $1,000
Salvage Value = $10,000
Lease payment = $10,000
Loan amortization for cash [payment and interest expense:
Payement: N =4, I/YR =10 , PV =40,000, FV = 0 , PMT = $12,618.83
Beg Bal(1)
Saving from Lease
Interest
Principal(2)
Ending Balance(1-2)
Year 1
$40,000
$12,619.00
$ 4,000.00
$ 8,619.00
$31,381.00
Year 2
$ 31,381.00
$12,619.00
$ 3,139.00
$ 9,481.00
$21,900.00
Year 3
$ 21,900.00
$12,619.00
$ 2,190.00
$10,429.00
$11,471.00
Year 4
$ 11,472.00
$12,619.00
$ 1,147.00
$11,472.00
$0.00
Principal PMTs =
Year 1 = PPMT (0.1, 1, 4,-40000); = $8,618.83
Year 2 = PPMT (0.1, 2, 4,-40000); = 9,480.72
Year 3 = PPMT (0.1, 3, 4,-40000); = $ 10,428.79
Year 4 = PPMT (0.1, 4, 4,-40000) = $11,471.67
Interest PMTs =
Year 1 = IPMT (0.1, 1, 4,-40000); = $4,000
Year2 = IPMT (0.1, 2, 4,-40000); = $3,138.12
Year 3 = IPMT (0.1, 3, 4,-40000); = $2,190.05
Year 4 = IPMT (0.1, 4, 4,-40000) = $ 1,147.17
Total savings on IPMT = Year X Interest PMT * 0.40
Depr. = $40,000 * MACRS rates for Years 1 to 4 are 0.33, 0.45, 0.15, and 0.07
Total savings on Depr. = Year X Depr * 0.40
Depreciation
Loan Payment
Savings on Interest
Maintenance(M)
Maintenance Tax saving(m*Tax rate)
Depreciation tax saving
Net operating CF
Resale
Tax on residual
Total Net CF
Year 1
$13,200
$(12,619.00)
$ 1,600.00
($1,000.00)
$400.00
$5,280.00
$ (6,339.00)
$ (6,339.00)
Year 2
$ 18,000.00
$(12,619.00)
$ 1,255.00
($1,000.00)
$400.00
$7,200.00
$ (4,764.00)
$ (4,764.00)
Year 3
$ 6,000.00
$(12,619.00)
$ 876.00
($1,000.00)
$400.00
$2,400.00
$ (9,943.00)
$ (9,943.00)
Year 4
$ 2,800.00
$(12,619.00)
$ 459.00
($1,000.00)
$400.00
$1,120.00
$ (11,640.00)
$10,000.00
($4,000.00)
$ (5,640.00)
PV of buying at I(1-T) = 6% -23,035
Lease Payment(1)
Tax Savings on PMT(2)
Net cost of saving(1+2)
Year 1
$(10,000.00)
$ 4,000.00
$ (6,000.00)
Year 2
$(10,000.00)
$ 4,000.00
$ (6,000.00)
Year 3
$(10,000.00)
$ 4,000.00
$ (6,000.00)
Year 4
$(10,000.00)
$ 4,000.00
$ (6,000.00)
PV of leasing at I(1-T) = 6% -22,038
Net advantage of leasing = 997
Beg Bal(1)
Saving from Lease
Interest
Principal(2)
Ending Balance(1-2)
Year 1
$40,000
$12,619.00
$ 4,000.00
$ 8,619.00
$31,381.00
Year 2
$ 31,381.00
$12,619.00
$ 3,139.00
$ 9,481.00
$21,900.00
Year 3
$ 21,900.00
$12,619.00
$ 2,190.00
$10,429.00
$11,471.00
Year 4
$ 11,472.00
$12,619.00
$ 1,147.00
$11,472.00
$0.00
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