Morris-meyer Mining Company must install 1.7 million of new machinery in its Nev
ID: 2726428 • Letter: M
Question
Morris-meyer Mining Company must install 1.7 million of new machinery in its Nevada mine. It can obatin a bank loan for 100% of the required amount. Alternativley, a Nevada investment banking from that represents a group of investors believes that it can arrange for a lease financing plan. Assume that the following facts apply:
1. The equipment falls in the MACRS 3 year class. the applicable MACRS rates are 30%, 43%, 13% and 7%.
2. Estimated maintenenace expenses are $70,000 per year.
3. Moriss-Meyer's federal plus state tax rate is 35%.
4. If the money is borrowed, the bank loan will be at a rate of 17%, amortizied in 4 equal installments to be paid at the end of the each year.
5. The tentaive lease terms call for end of year payments of $250,000 which is the expecteed market value after 4 years,
6. Under the proposed lease terms, the lessee must pay for insurance, property taxes, and maintenance.
7. The equipment has an estimated salvage value of $250,000, which is the xpected market value after 4 years, at which time Morris-Meyer plans to repolace the equipment regardless of whether the firm leases or purchases it. The best estimate for the salvage value is $250,000, but it may be much higher or lower under certain circumstances.
To assist managment in marking the proper lease versus buy decision, you are asked to anser the following quesitons,
a. Assuming that the lease can be arranged, should Morris=Meyer lease or borrow and buy the equipment?
Net advantage to leasing (NAL) is ________________?
Explanation / Answer
Machine cost $ 1,700,000 Depreciation Year 1 Year 2 Year 3 Year 4 MACRS Depreciation rate 30% 43% 13% 7% MACRS depreciation Amount 510,000 731,000 221,000 119,000 Book Value after Year4 119,000 Salvage value afer 4 years 250,000 Tax rate 35% Post Tax salvage value= 162,500 Lease Amortization Formula for loan amortization = A= [i*P*(1+i)^n]/[(1+i)^n-1] Amt $ A = periodical installment ? P=Loan amount = 1,700,000 i= interest rate per period = 17.000% n=total no of payments 4 A=[0.17*1700000*1.17^4]/(1.17^4-1) A =$619706 So Annual Installment= 619,706 Amortization Year Installment Ineterst Principal Repaid Balance Principal Year 1 619,706 289,000 330,706 1,369,294 Year 2 619,706 232,780 386,926 982,368 Year 3 619,706 167,003 452,703 529,665 Year 4 619,706 90,043 529,663 2 Loan Details Year Principal Prepaid Interest Paid Post Tax Interest Depreciation Depreciation Tax shield@35% tax End of Term lease payment Annual Maintenance Post Tax Salvage Net Cost of Lease PV factor @17% PV of Net Costs Year 1 330,706 289,000 187,850 510,000 (178,500) 70,000 410,056 0.8547 350,475 Year 2 386,926 232,780 151,307 731,000 (255,850) 70,000 352,383 0.7305 257,421 Year 3 452,703 167,003 108,552 221,000 (77,350) 70,000 553,905 0.6244 345,842 Year 4 529,663 90,043 58,528 119,000 (41,650) 250,000 70,000 (162,500) 704,041 0.5337 375,711 1,329,449 Net PV of Leasing 1,329,449 Buying Details Loan amount 1,700,000 Year Interest Post Tax Interest Loan Repayment Depreciation Tax shield@35% tax Post Tax Salvage Net Cost of Buying PV factor @17% PV of Net Costs Year 1 289,000 187,850 (178,500) 9,350 0.8547 7,991 Year 2 289,000 187,850 (255,850) (68,000) 0.7305 (49,675) Year 3 289,000 187,850 (77,350) 110,500 0.6244 68,993 Year 4 289,000 187,850 1,700,000 (41,650) (162,500) 1,683,700 0.5337 898,507 925,816 Net PV of Buying 925,816 So Net Advantage to Leasing =925816-1329449= $ (403,633.2) So NAL is negative
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