Barclay Polymers needs to acquire a new extruding machine whose purchase price i

Question

Barclay Polymers needs to acquire a new extruding machine whose purchase price is $600,000. However, the firm could lease the extruder for a 5 year period and make annual payments of $115,000 at the beginning of each year. If the extruder is leased, then the leasing company will pay all maintenance costs and Barclay would have the opportunity to purchase the asset for $130,000 at the beginning of year 5. If the exctruder is purchased by Barclay, then it will be financed with a 5 year loan at an annual rate of 8.75%. Barclay would use MACRS depreciation method over the 5 year recovery period, would purchase a service contract for $8,000 per year and would keep the extruder after its recovery period. If the firm pursues the purchase alternative, then it would secure a maintenance contract expected to cost $3,000 annually. The firm is in the 35% tax brakcet.

A) Calculate the annual after-tax out flow for the leasing alternative

B) Determine the annual interest and Principal payments for the purchase alternative

C) Determine the annual depreciation deduction for the purchase alternative

D) Calculate the new present value of both the leasing and purchase alternatives. Which method should Barclay use?

Explanation / Answer

A) Calculate the annual after-tax out flow for the leasing alternative

Annual after tax cash outflow for the leasing alternative would be - Annual lease payment*(1-Tax rate)

= $115,000(1-0.35) = $74,750

B) Determine the annual interest and Principal payments for the purchase alternative

Equated yearly payment of loan = Principal / PVF (5years,8.75%)

= $600,000/3.916 = 153,218/-

C) Determine the annual depreciation deduction for the purchase alternative

Year 1= 20%*$600,000 = $120,000

Year 2 = 32%*$600,000 = $192,000

Year 3 = 19.20%*$600,000 = $115,200

Year 4 = 11.52%*$600,000 = $69,120

Year 5 = 11.52%*$600,000 = $69,120

Year 6 = 5.76%*$600,000 = $34,560

D) Calculate the new present value of both the leasing and purchase alternatives. Which method should Barclay use?

Net present value of both alternatives:-

Net of tax

outflow

of 65%

Cash ouflow

Benefit

Presentvalue

of cash outflow

Cash outflow from purchase alternative = $600,000- $178,779 = $421,221

Cash outflow from leasing alternative = $74,750*3.916 + $130,000*0.715 = $385,671

Leasing alternative shall be used to obtain the extruder.

Year Opening principal Interest 8.75% Payment Closing principal 1 600,000 52,500 100,718 499,282 2 499,282 43,687 109,531 389,751 3 389,751 34,103 119,115 270,636 4 270,636 23,681 129,537 141,099 5 141,099 12,346 141099 0 Total 166,317 600,000

Related Questions

Navigate

• Browse (All)
• Browse B
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.