A contractor who has to perform a considerable amount of excavation work is well

Question

A contractor who has to perform a considerable amount of excavation work is well advised to analyze the options of renting versus buying equipment to perform the work is well By renting equipment, the contractor does not require the large investment that is associated with buying equipment, and the firm does not commit itself to future interest expense associated with financing purchased equipment and the firm does not commit itself to future interest expense associated with financing purchased equipment. On the other hand, rental equipment may result in a higher hourly cost versus the hourly cost of owning the equipment. Assume that a contractor estimates that the next year, he will have to perform 450,000 cubic yards of excavation work. Assume that the firm determines that a back hoe that will perform the work can be rented for a month cost of $8,500. Another option would be to purchase the equipment a, a cost, of $120,000. The purchase of equipment would be by means of a $20,000 equity investment, and the securing of a 5-year loan for $100,000 at an interest rate of 15% compounded annually. Assume that the equipment can be depreciated over a 5-year life at an accelerated rate of 175%. When the equipment is rented, the contractor has no obligation for the maintenance cost of the equipment. This ownership cost is estimated at $15,000 per year. Assume the contractor is in the 40% income tax bracket. Given the fact that rental expenses, finance costs, depreciation, and maintenance costs are tax-deductible, on the basis of a 1-year analysis, determine the unit cost per cubic yard of performing the work both with the rental equipment and by means of purchased equipment.

Explanation / Answer

Solution :

By comparing the Purchase & Rental catrgory its better to go for purchase by considering the NPA & upcoming order for machine.

Item to Purchase Excavation Equipment Marginal Tax Rate 40.00% Discount Rate Current market Value of Trade-in $ $120,000.00 Undepreciatied Value of Trade-in $ $0.00 Cost of Machine Sold or Traded    $ $0.00 Sell or Trade (1 or 2) 1 Machinery Group Number (1-4) 1 Depreciation Class, 3, 5, or 7yr (3 , 5 or 7) 5 Capital Gains Tax Rate (% Gain Taxed) 0.00% Annual Cash Operating Expenses $15,000.00 Expected Annual Inflation Rate 2.50% PURCHASE INFORMATION Purchase Price ($) $120,000.00 Amount to Finance ($) $100,000.00 Downpayment $20,000 Interest rate 15.00% Years to Finance Yrs 5 Number of Years for Analysis Yrs 5 Calculated Payment (Annual Payments Assumed) $29,832 Amount Expensed ($) $0.00 Investment Credit Taken 0% Investment Credit Applicable $0 Depreciable Basis $120,000 Estimated salvage Value $53,781 Tax Adjusted Discount Rate 0.00%

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