Neiman\'s is considering the acquisition of a new processor used in its operatio

Question

Neiman's is considering the acquisition of a new processor used in its operation. The processor has an installed cost of $56,000 and is expected to have a useful life of 5 years. If purchased, the firm company would borrow the entire $56,000 at an interest rate of 12%. The processor would be depreciated over a 5 year ACRS life to a zero book value, but it is estimated that it could be sold for $6,000 after 5 years. A capital budgeting analysis indicates that purchase of the processor has a positive NPV. Alternatively, Neiman's can lease the processor for the 5 year period for an annual lease payment of $13,000. If the processor is leased, annual operating expenses of $2,300 will be paid by the lessor. If the equipment is purchased, the firm will incur this expense. Neiman's cost of capital is 12% and its marginal tax rate is 35%.

If Neiman's borrows to purchase the processor, what is the annual loan payment?

If Neiman's borrows to purchase the processor, the interest paid on the loan in year 2 is?

If Neiman's borrows to purchase the processor, total tax deductible expenses for year 3 are?

If Neiman's borrows to purchase the processor, the net cost of owning for year 3 is?

The present value of the costs of owning is?

The present value of the cost of leasing the processor is?

Explanation / Answer

1) Annual loan payment = 56000/pvifa(12,5) = 56000/3.6048 = $15,535

2) Interest paid on the loan in year 2 is $5,662.

Calculations:

3) Total tax deductible expenses for year 3:

= Interest + Annual operating expenses + Depreciation = 4477+2300+11760 = $18,537

4) Net cost of owning for year 3 is $10,004

5) PV of costs of owning is $34,412

Calculations:

6) PV of cost of leasing = 13000*0.65*pvifa(7.8,5) = 13000*.65*4.0138 = $33,917

Beginning Payment of Repayment Ending Year loan amount Interest of principal Loan amount 1 56000 6720 8815 47185 2 47185 5662 9873 37312 3 37312 4477 11058 26255 4 26255 3151 12384 13870 5 13870 1664 13871 0

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