The Prescott Welding Company needs to acquire a new lift truck for transporting

Question

The Prescott Welding Company needs to acquire a new lift truck for transporting its final product to the CH10 warehouse. One alternative is to purchase the truck for $45,000, which will be financed by the bank at an 31P interest rate of 12%. The loan must be repaid in four equal installments, payable at the end of each year
Under the borrow-to-purchase arrangement, Prescott Welding would have to maintain the truck at an

annual cost of $1,200, also payable at year-end. Alternatively, Prescott Welding could lease the truck under a four-year contract for a lease payment of $12.000 per year. Each annual lease payment must be made at the beginning of each year. The truck would be maintained by the lessor. The truck falls into the five-year MACRS classification, and it has a salvage value of $10,000, which is the expected market value after four years, at which time Prescott Welding plans to replace the truck, irrespective of whether it leases or buys. Prescott Welding has a marginal tax rate of 40% and a MARR of 15%.

(a) What is Prescott Welding’s cost of leasing in present worth? (b) What is Prescott Welding’s cost of owning in present worth? (c) Should the truck be leased or purchased?

Explanation / Answer

a. The present value of leasing the truck is calculated by using the =pv(rate,nper,pmt,fv,type)

Here rate = 15% = 0.15, nper = 4, pmt = 12000 and type = 1 since it is at the beginning of the year

So cost of leasing in present worth is =pv(0.15,4,12000,0,1) = $39,398.70

b. Cost of owning:

The cost of the loan is the loan installment + the charges - the salvage value at the end

The cost of loan instaments is =pmt(rate,nper,pv) =pmt(0.12,4,45000) = 14,815.55

Th e cost of maintenenace = 1200 + 14,815 .55 = 16,015.55

Hence the PV of these Costs are =pv(rate,nper,pmt) =pv(0.15,4,16015.55) = $45,724.05

The PV of the benefit of selling the truck:

Sale price = 10000

Depreciation total percentage= 82.72% ( 20% + 32% + 19.2% + 11.52% depreciation for 4 years asper MACRS table)

Book Value = 45000 = 0.8272*45000 = 7776

Profit = 10000-7776 = 2224

So tax paid is 0.4*2224 = 889.6

So Profit = 10000-889.6 = 9110.40

The present value of this is 9110.40/1.15^4 = $5208.90

Hence Total cost of owning = $45,724.05 -$5208.90 = $40,515.15

(c) Leasing is a better option as its costs are lower

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