Kohlberg Inc. is considering a leasing arrangement to finance some manufacturing

ID: 2773386 • Letter: K

Question

Kohlberg Inc. is considering a leasing arrangement to finance some manufacturing tools that it needs for the next 3 years. The tools will be obsolete and worthless after 3 years. The firm will depreciate the cost of the tools on a straight-line basis over their 3-year life. It can borrow $4,800,000, the purchase price, at 10% and buy the tools, or it can make 3 equal end-of-year lease payments of $2,100,000 each and lease them. The loan obtained from the bank is a 3-year simple interest loan, with interest paid at the end of the year. The firm's tax rate is 40%. Annual maintenance costs associated with ownership are estimated at $240,000, but this cost would be borne by the lessor if it leases. What is the net advantage to leasing (NAL), in thousands?

$106

$123

$96

$106

$123

$96

Explanation / Answer

Calculation of net advantage to leasing (NAL):

Figures in $ Thousands

Year 0

Year 1

Year 2

Year 3

Saving of Cost of Asset (Loan to be repay at the end)

4,800

Saving of Interest Cost (Net of tax) = 4800*10% *(1-40%)

288

Saving of Annual Maintenance Cost (Net of tax) = 240*(1-40%)

144

Less: Loss of tax saving on depreciation = (4800/3)*40%

(640)

Less: Lease rental (Net of tax) = 2100*(1-40%)

(1,260)

Total Net Cash Flows (CF)

(1,468)

3,332

PVF 10%*(1-40%) = (6%)

1.00000

0.94340

0.89000

0.83962

PV = CF *PVF

(1,384.91)

(1,306.51)

2,797.61

NAL = Sum of PVs

106

Hence Net Advantage from Lease (NAL) is $106 Thousands