Modern Medical Mechanics replaces a production machine that cannot be repaired e

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Modern Medical Mechanics replaces a production machine that cannot be repaired economically every two years with a new machine.   They have found that the lost production time doing repairs after two years is prohibitively high. The vendor of the machine will sell or lease the machine. A financial analysis is needed to evaluate the alternatives of leasing versus buying using a 4-year time frame and a MARR of 12.5%.   The replacement machine, being identical to the existing machine, will not affect revenues nor costs. Maintenance costs are minor and will be done in-house for both alternatives. The present machine is fully depreciated and will be discarded (no salvage value).   The machine can be purchased for $41,000 and will be paid for in years 0 and 2. The machine can be sold for $27,000 that will be received in the year following the purchase of a new one (e.g. year 3 and 5). It will be depreciated using 5-year MACRS. The leased machine will cost $1,200 monthly that is to be paid at the beginning of each month. It also will be replaced every two years. The changeover cost for both alternatives would be identical so can be ignored. Modern Medical Mechanics uses an Income tax rate of 20% and capital gains tax rate of 12.5%. a Perform a financial analysis of the "buy" alternative. b Perform a financial analysis of the lease alternative. c Make a recommendation of which alternative should be adopted and why. Solution Modern Medical Mechanics replaces a production machine that cannot be repaired economically every two years with a new machine.   They have found that the lost production time doing repairs after two years is prohibitively high. The vendor of the machine will sell or lease the machine. A financial analysis is needed to evaluate the alternatives of leasing versus buying using a 4-year time frame and a MARR of 12.5%.   The replacement machine, being identical to the existing machine, will not affect revenues nor costs. Maintenance costs are minor and will be done in-house for both alternatives. The present machine is fully depreciated and will be discarded (no salvage value).   The machine can be purchased for $41,000 and will be paid for in years 0 and 2. The machine can be sold for $27,000 that will be received in the year following the purchase of a new one (e.g. year 3 and 5). It will be depreciated using 5-year MACRS. The leased machine will cost $1,200 monthly that is to be paid at the beginning of each month. It also will be replaced every two years. The changeover cost for both alternatives would be identical so can be ignored. Modern Medical Mechanics uses an Income tax rate of 20% and capital gains tax rate of 12.5%. a Perform a financial analysis of the "buy" alternative. b Perform a financial analysis of the lease alternative. c Make a recommendation of which alternative should be adopted and why. Solution

Explanation / Answer

Buy option Year 0 1 2 3 4 5 -41000 -41000 -41000 27000 27000 Total cost -69000 Lease option Year 0 1 2 3 4 5 -14400 -14400 -14400 -14400 -14400 -14400 Total cost -86400 Buying the asset is profitible as you would get a return value of 27000 for the investment Whereas the lease payment doesnot give any return ,it’s just a cash outflow Hence its always profitable to buy the asset also we get the tax benefit of depretiation if we buy the asset There would be no benefit of tax if we take the asset on lease as we do not own the asset Also if we do analysis till 5 years buying the asset is financially more profitible

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