1. Assuming 0% taxes. Equipment can be leased at $12000 per year (first payment
ID: 2797477 • Letter: 1
Question
1. Assuming 0% taxes. Equipment can be leased at $12000 per year (first payment at end of year) for nine years or purchased at a cost of $68000. The company has a weighted average cost of capital of 12%. A bank has indicated that it would be willing to make the loan of $68000 at a cost of 10%. There is no salvage value. Assume a marginal tax rate of 40% and that a loan can be obtained from the bank at a cost of 9%. Should the firm buy or lease? The PV of the depreciation expense is 60% of the original investment. Assume a 5.4% discount rate.
A Lease; PV of Lease option lower than Buy option
B Lease; PV of Buy option lower than Lease option
C Buy; PV of Buy option lower than Lease option
D none of them
E Buy; PV of Lease option lower than Buy option
2. Referring to Q1. If the lease payments start at the beginning of the year, would your recommendation change? How?
A Buy; PV of Buy option lower than Lease option
B Lease; PV of Lease option lower than Buy option
C Lease; PV of Buy option lower than Lease option
D Buy; PV of Lease option lower than Buy option
E none of them
Explanation / Answer
option 1) lease
Statement showing present value
Option 2) Buy
First of all lets calculate installments
Installments = loan/PVIFA(9%,9 years)
=68000/(5.995)
=11342.32
Repayment schedule
Statement showing PV of cash flow
Thus one should lease since PV of lease option is lower than buy option
2) If lease payment were made at begining of year
PV of lease=(12000*0.6)+(12000*0.6)*PVIFA(5.4%,8years)
=7200+7200*6.36
=7200+45792
=$52992
In this case it is advisable to buy since PV of buy option is lower than lease option
Year Lease payment Tax @ 40% After tax cash flow PVIF @ 5.4% PV 1 12000 4800 7200 0.9488 6831.120 2 12000 4800 7200 0.9002 6481.138 3 12000 4800 7200 0.8540 6149.087 4 12000 4800 7200 0.8103 5834.049 5 12000 4800 7200 0.7688 5535.151 6 12000 4800 7200 0.7294 5251.566 7 12000 4800 7200 0.6920 4982.510 8 12000 4800 7200 0.6566 4727.240 9 12000 4800 7200 0.6229 4485.047 50276.91Related Questions
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