The equipment costs $1,000,000, and, if it were purchased, Lewis could obtain a

Question

The equipment costs $1,000,000, and, if it were purchased, Lewis could obtain a term loan for the full purchase price at a 10 percent interest rate. Although the equipment has a six-year useful life, it is classified as a special-purpose computer, so it falls into the MACRS three-year class. If the system were purchased, a four-year maintenance contract could be obtained at a cost of $20,000 per year, payable at the beginning of each year. The equipment would be sold after four years, and the best estimate of its residual value at that time is $200,000. However, since real-time display system technology is changing rapidly, the actual residual value is uncertain. As an alternative to the borrow-and-buy plan, the equipment manufacturer informed Lewis that Consolidated Leasing would be willing to write a four-year guideline lease on the equipment, including maintenance, for payments of $260,000 at the beginning of each year. Lewis's marginal federal-plus-state tax rate is 40 percent. You have been asked to analyze the lease-versus-purchase decision, and in the process to answer the following questions: A. What is the present value cost of owning the equipment?

B. What is the present value cost of leasing the equipment? If the equipment is leased

c. What is the net advantage to leasing (NAL)?

d. Answer these questions one at a time to see the effect of the change on NAL. That is, starting with the original numbers you used for questions a. and b., what is the NAL if: - interest rate increases to 12 percent - the tax rate falls to 34 percent - maintenance cost increases to $25,000 per year - residual value falls to $150,000 - the system price increases to $1,050,000

e. Do the changes in d. make leasing more or less attractive? Explain.

I have had two completly different answers?

Explanation / Answer

taxrate 40% t cost of debt 10% r rate=r*(1-t) 6.00% after tax cost of debt Leasing Year(n) Lease Pay TaxSaved Net CF PV of CF (A) (-A*taxrate) CF=A(1-taxrate) CF/(1+rate)^n 0 -2,60,000 1,04,000.00 -1,56,000.00 -156000.00 1 -2,60,000 1,04,000.00 -1,56,000.00 -147169.81 2 -2,60,000 1,04,000.00 -1,56,000.00 -138839.44 3 -2,60,000 1,04,000.00 -1,56,000.00 -130980.61 NPV(sum PVs) -572989.86 Beg. Book Value(BV0)    10,00,000 Economic Life(T yrs) 4 Depreciation Schedule Beginning Macrsrate Depreciation Ending Year(n) BookValue(n) Expense BookValue(n) BV(n-1) rate (d=rate*BV0 BV(n)=BV(n-1)-d 0 10,00,000 1 10,00,000 33.33% 333300.00 6,66,700 2 6,66,700 44.45% 444500.00 2,22,200 3 2,22,200 14.81% 148100.00 74,100 4 74,100 7.41% 74100.00 0 Initial Loan Balance               10,00,000 Rate 10.00% Term (years)                                4 Amortised pay(AP) $3,15,470.80 (=Initial Loan Balance*(Rate)/(1-(1/(1+Rate)^(Term)))) Amortisation Schedule Year Amortised pay Beg Loan Balance Principal Interest End Loan Balance (n) AP MB(n-1) (P(n)=AP-Interest) (Rate*MB(n-1)) MB(n)=MB(n-1)-P(n) 0 10,00,000 1 315470.80 10,00,000 2,15,471 100000.00 7,84,529 2 315470.80 7,84,529 2,37,018 78452.92 5,47,511 3 315470.80 5,47,511 2,60,720 54751.13 2,86,792 4 315470.80 2,86,792 2,86,792 28679.16 0 Purchase Year Maintainance Interest Depreciation EBIT TaxSaving(TS) NetIncome NetCashFlow Loan Repay Salvage Value CF(a) TotalNCF= PV (n) (m) (I) (d) (=-(m+d+I)) (-taxrate*(EBIT)) NI=EBIT+TS NCF=NI+d Repay=P(n)       SV-taxrate(SV-BV) NCF+Repay+a (TotalNCF/(1+rate)^n 20,000 -20,000.00 -20000.00 1 20,000 100000.00 333300.00 -4,53,300.00 181320.00 -2,71,980.00 61,320.00 -2,15,471 -1,54,150.80 -145425.29 2 20,000 78452.92 444500.00 -5,42,952.92 217181.17 -3,25,771.75 1,18,728.25 -2,37,018 -1,18,289.64 -105277.35 3 20,000 54751.13 148100.00 -2,22,851.13 89140.45 -1,33,710.68 14,389.32 -2,60,720 -2,46,330.35 -206823.71 4 0 28679.16 74100.00 -1,02,779.16 41111.67 -61,667.50 12,432.50 -2,86,792 -2,74,359.14 -217318.13 5 0 0 0 0 0 0 0 0 0 0.00 0.00 6 0 0 0 0 0 0 0 0 1,20,000 1,20,000.00 84595.26 NPV -610249.22 Net Advantage of Leasing $         37,259.36 (NPV of Leasing-NPV of Purchase) The Leasing is more profitable venture than purchasing by $                  37,259.36 Therefore You should choose NAL effect interest rate increases to 12 percent 58789.56218 increases tax rate falls to 34 percent 39315.55539 increases maintenance cost increases to $25,000 /year 50278.39583 increases residual value falls to $150,000 58408.17619 increases the system price increases to $1,050,000 69397.77726 increases Changes makes the leasing more attractive.

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