To finance some manufacturing tools it needs for the next 4 years, Waldrop Corpo
ID: 2773933 • Letter: T
Question
To finance some manufacturing tools it needs for the next 4 years, Waldrop Corporation is considering a leasing arrangement.
Waldrop Corporation has no use for the machine beyond the expiration of the lease, and the machine has an estimated residual value of $250,000 at the end of the 4th year.
The machinery falls into the MACRS 3-year class. The MACRS allowance factors are 0.3333, 0.4445, 0.1481, and 0.0741 for Year 1, 2, 3, 4, respectively.
It can borrow $1.58 million, the purchase price, at an interest rate of 15% and buy the tools, or it can make four (4) equal end-of-year lease payments of $400,000 each and lease them.
The loan obtained from the bank is a 4-year simple interest loan, with interest paid at the end of each year for four years and the principal repaid at Year 4.
The firm's tax rate is 40%.
Under either the lease or the purchase, Waldrop Corporation must pay for insurance, property taxes, and maintenance.
What is the net advantage to leasing (NAL)?
Explanation / Answer
Cost of Buying :
Year 1 Cash flow = - Post tax interest payment + Depreciation * tax rate
Year 1 Cash flow = -1580000*15%*(1-40%) + 1580000*0.3333*40%
Year 1 Cash flow = $ 68445.60
Year 2 Cash flow = - Post tax interest payment + Depreciation * tax rate
Year 2 Cash flow = -1580000*15%*(1-40%) + 1580000*0.4445*40%
Year 2 Cash flow = $ 138,724
Year 3 Cash flow = - Post tax interest payment + Depreciation * tax rate
Year 3 Cash flow = -1580000*15%*(1-40%) + 1580000*0.1481*40%
Year 3 Cash flow = - $ 48,600.80
Year 4 Cash flow = - Post tax interest payment + Depreciation * tax rate - Principal payment + Post tax salvage value
Year 4 Cash flow = -1580000*15%*(1-40%) + 1580000*0.0741*40% - 1580000 + 250000*(1-40%)
Year 4 Cash flow = - $ 1,525,368.80
Present Value = 68445.60/1.15 + 138724/1.15^2 - 48600.80/1.15^3 - 1525368.80/1.15^4
Present Value = $ - 739,677.19
Cost of Leasing
Annual Post tax lease payment = lease payment*(1-tax rate)
Annual Post tax lease payment = 400000*(1-40%)
Annual Post tax lease payment = 240000
Present value = -240000*(1- (1+15%)^-4)/15%
Present value = -$685194.81
NAL = Present Value of Cost of Leasing - Present Value of Cost of Buying
NAL = - 685194.81 -(-739677.19)
NAL = $ 54,482.38
Answer
NAL = $ 54,482.38
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