Morris-Meyer Mining Company must install $1.7 million of new machinery in its Ne

Question

Morris-Meyer Mining Company must install $1.7 million of new machinery in its Nevada mine. It can obtain a bank loan for 100% of the required amount. Alternatively, 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: The equipment falls in the MACRS 3-year class. The applicable MACRS rates are 33%, 40%, 14%, and 8%. Estimated maintenance expenses are $80,000 per year. Morris-Meyer's federal-plus-state tax rate is 40%. If the money is borrowed, the bank loan will be at a rate of 14%, amortized in 4 equal installments to be paid at the end of each year. The tentative lease terms call for end-of-year payments of $300,000 per year for 4 year. Under the proposed lease terms, the lessee must pay for insurance, property taxes, and maintenance. The equipment has an estimated salvage value of $300,000, which is the expected market value after 4 years, at which time Morris-Meyer plans to replace the equipment regardless of whether the firm leases or purchases it. The best estimate for the salvage value is $300,000, but it may be much higher or lower under certain circumstances. To assist management in marking the proper lease-versus-buy decision, you are asked to answer the following questions. Assuming that the lease can be arranged, should Morris-Meyer lease or borrow and buy the equipment? Explain. Round your answer to the whole number. Net advantage to leasing (NAL) is $_____ . (Input the minus sign if the cost of leasing the machinery is more than the cost of owning it.)

Please answer for NAL.

Explanation / Answer

Annuity Factor of 14% for 4 years 2.9137 Loan 1700000 EMI (Loan/Annuity Factor) 583448 Buying option Year 0 1 2 3 4 Depreciation 561000 680000 238000 136000 Maintenance 80000 80000 80000 80000 EMI 583448 583448 583448 583448 Interest 238000 189637.2616 134503.7398 71651.52493 Loan Balance 1700000 1354552 960741 511797 0 Sum of Depreciation, maintenance and Interest 879000 949637 452504 287652 Tax shield on above 351600 379855 181001 115061 Net cash outflow 231848 203593 402447 468388 Lease Option Year 0 1 2 3 4 Maintenance 80000 80000 80000 80000 Lease Payment 300000 300000 300000 300000 Sum of Depreciation, maintenance and Interest 380000 380000 380000 380000 Tax shield on above 152000 152000 152000 152000 Net cash outflow 148000 148000 148000 148000 Saving in Cash flow for Lease 83848 55593 254447 320388 DF @ 14% 1 0.877 0.769 0.675 0.592 Present value of lease benefit 73551 42777 171744 189695 477768 Net advantage to leasing (NAL) is $ $       4,77,768 Cost of return Market rate of interest 14%

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