Delamont Transport Company (DTC) is evaluating the merits of leasing versus purc
ID: 2715182 • 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. 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%. (Note: MACRS rates for Years 1 to 4 are 0.3333, 0.4445, 0.1481, and 0.0741).
Question: How much is the principal repayment on the loan in Year 2?
$10,000
$9,481
$9,692
$9,144
Question: How much is the after-tax interest payment on the loan in Year 3?
$2,190
$3,138
$1,883
$1,314
Question: How much is the depreciation tax savings in Year 1?
$5,333
$7,112
$13,332
$2,964
Question: How much is the Year 4 net cash costs if the truck is financed with debt?
$11,5743
$6,286
-$1,574
-$5,574
Question: What is the net advantage to leasing (NAL)?
-$1,199
$1,199
$999
-$2,074
a.$10,000
b.$9,481
c.$9,692
d.$9,144
Explanation / Answer
Question: How much is the principal repayment on the loan in Year 2?
Annual Payment = 40000/((1-(1+10%)^-4)/10%)
Annual Payment = 12618.83
Principal outstanding after Year 1 = 40000 + 40000*10% - 12618.83
Principal outstanding after Year 1 = 31381.17
Principal repayment on the loan in Year 2 =12618.83 - 31381.17*10%
Principal repayment on the loan in Year 2 = $ 9481
Answer
b)$9,481
Question: How much is the after-tax interest payment on the loan in Year 3?
Principal outstanding after Year 2 = 31381.17 - 9481
Principal outstanding after Year 2 = $ 21900.17
Interest payment = 21900.17*10%
Interest payment = $ 2190
After-tax interest payment on the loan in Year 3 = 2190*(1-40%)
After-tax interest payment on the loan in Year 3 = $ 1314
Answer
b) $1,314
Question: How much is the depreciation tax savings in Year 1?
Depreciation tax savings in Year 1 = Depreciation Expense*Tax rate
Depreciation tax savings in Year 1 = 40000*0.3333*40%
Depreciation tax savings in Year 1 = $ 5333
Answer
a) $5,333
Question: How much is the Year 4 net cash costs if the truck is financed with debt?
Answer
-$5,574
Question: What is the net advantage to leasing (NAL)?
PV of Buying = -21025
PV of Leasing = - PV of Lease Payment + PV of tax saving on lease paymen
PV of Leasing = -10000 - 10000*(1-(1+10%)^-3)/10% + 10000*40%*(1-(1+10%)^-4)/10%
PV of Leasing = - 22189
NAL = -22189 - (-21025)
NAL = -1164
Answer
a) -1199
Note : Difference is due to rounding off
Year 1 Year 2 Year 3 Year 4 Annual Loan Payment [a] 12,619.00 12,619.00 12,619.00 12,619.00 Interest Expenses [b] 4,000.00 3,138.00 2,190.00 1,148.00 Depreciation Rate [c] 0.3333 0.4445 0.1481 0.0741 Depreciation Expenses [d = 40000*c] 13,332.00 17,780.00 5,924.00 2,964.00 Depreciation Tax shield [e = d*tax rate] 5,332.80 7,112.00 2,369.60 1,185.60 Interest Tax shield [f= b*tax rate] 1,600.00 1,255.20 876.00 459.20 Post Tax Mainetnance Expenses [g = 1000*60%] 600.00 600.00 600.00 600.00 Post Tax salvage value [h = 10000*60%] 6,000.00 Net cash Flow [i= -a+e+f-g+h] - 6,286.20 - 4,851.80 - 9,973.40 - 5,574.20Related Questions
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