High electricity costs have made Farmer Corporation’s chicken-plucking machine e

Question

High electricity costs have made Farmer Corporation’s chicken-plucking machine economically worthless. Only two machines are available to replace it. The International Plucking Machine (IPM) model is available only on a lease basis. The lease payments will be $77,000 for five years, due at the beginning of each year. This machine will save Farmer $27,000 per year through reductions in electricity costs. As an alternative, Farmer can purchase a more energy-efficient machine from Basic Machine Corporation (BMC) for $390,000. This machine will save $37,000 per year in electricity costs. A local bank has offered to finance the machine with a $390,000 loan. The interest rate on the loan will be 11 percent on the remaining balance and will require five annual principal payments of $78,000. Farmer has a target debt-to-asset ratio of 68 percent. Farmer is in the 40 percent tax bracket. After five years, both machines will be worthless. The machines will be depreciated on a straight-line basis.

How much debt is displaced by this lease? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Explanation / Answer

year IPM BMC lease payment/purchase cost 3,85,000 4,00,000 savings in electricity -1,35,000 -1,85,000 1 Interest payment on loan 44,000 2 28,800 3 21,600 4 14,400 5 7,200 Total cost 2,50,000 3,31,000 NAL of leasing is $ 81,000 $77,000 is displaced by this lease.

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