Happy Cleaners needs a new steam machine that costs $100,000. The company is eva

Question

Happy Cleaners needs a new steam machine that costs $100,000. The company is evaluating whether it should lease or purchase the machine. The equipment falls into the MACRS 3-year class, and it would be used for 3 years and then sold, because the firm plans to move to a new facility at that time. The estimated value of the equipment after 3 years is $30,000. A maintenance contract on the equipment would cost $3,000 per year, payable at the beginning of each year. Alternatively, the firm could lease the equipment for 3 years for a lease payment of $29,000 per year, payable at the beginning of each year. The lease would include maintenance. The firm is in the 20% tax bracket, and it could obtain a 3-year simple interest loan, interest payable at the end of the year, to purchase the equipment at a before-tax cost of 10%. If there is a positive Net Advantage to Leasing the firm will lease the equipment. Otherwise, it will buy it. What is the NAL?

Explanation / Answer

Net Advantage to Leasing = PV of Cost of Leasing - pV of cost of buying

Net Advantage to Leasing = -64896.20 - (-66937.42)

Net Advantage to Leasing = 2041.22

Decision : the firm will lease the equipment

Now 1 2 3 Purchase Alternative Purchase of Machine , taken loan [a] -100000 Interest Payment [b] -10000 -10000 -10000 Annual Maintenance Cost [c] -3000 -3000 -3000 Annual Depreciation [d] 33330 44450 14810 Tax shield on Interest maintenance & depreciation [e = (d-b-c)*20%]         9,266.00    11,490.00          5,562.00 Salvage Value [f] 30000 Tax on Salvage Value [g = (20%* (30000 -100000* 7.41% ))          4,518.00 Total Cash flow [h = a +b+c+e+f -g]                     (3,000.00)      (3,734.00)    (1,510.00)     (78,956.00) Discount Factor @10% 1.000 0.909 0.826 0.751 Present Value -3000.00 -3394.21 -1247.26 -59295.96 Net Present Value -66937.42 Lease Alternative Annual Lease Payment -29000 -29000 -29000 Tax saving on Lease Payment 5800 5800 5800 Total Cash flow -29000 -23200 -23200 5800 Discount Factor 1.000 0.909 0.826 0.751 Present Value -29000.00 -21088.80 -19163.20 4355.80 Net Present Value -64896.20

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