Furman Industries is negotiating a lease on a new piece of equipment that would
ID: 2802209 • Letter: F
Question
Furman Industries is negotiating a lease on a new piece of equipment that would cost $100,000 if purchased. The equipment falls into the MACRS 3-year class, and it would be used for 3 years and then sold, because Furman plans to move to a new facility at that time. The applicable MACRS depreciation rates are 0.33, 0.45, 0.15, and 0.07. It is estimated that the equipment could be sold for $30,000 after 3 years of use. A maintenance contract on the equipment would cost $3,000 per year, payable at the beginning of each year of usage. Conversely, Furman could lease the equipment for 3 years for a lease payment of $29,000 per year, payable at the beginning of each year. The lease would include maintenance. Furman is in the 20 percent tax bracket, and it could obtain loan to purchase the equipment with 3 years non-amortization loan at a before-tax cost of 10 percent. Is it a Net Advantage to Leasing or to purchasing? what is the amount of the advantage?
Explanation / Answer
Purchasing:
Cost of the equipment=$100,000.
Tax savings on account of depreciation is as follows:
Loan is to be repaid after 3 years.
Present value of loan repayment=$100,000*1/1.08^3
=0.7938332*100000
=79383.22.----------(2)
Interest paid net of tax savings on interest.=(10000-2000)*1/(1+.08)^-3/.08
=8000*2.577
=20,616.7759--------(3)
Annual maintenance cost:
Present value of annual maintenance cost after tax savings=$3000*(1-.20)*Present value annuityfactor
=$2,400*2.577
=$6,185.03-------------(4)
Present value of salvage proceeds:
Salvage value=$30,000.
Book value af the end of year3=$100000*.07
=7000.
Gain on sale=$30,000 -$7,000
=$23,000.
After tax value of gain=$23,000*(1-.2)
=18,400
Present value of after tax salvage value=$18,400*1/1.08^3
=$14,606.51---------------(5)
Cash outflow on purchase of equipment=(2)-(1)+(3)+(4)-(5)
=$79,383.22-$16,208.66+20,616.78+$6,185.03-$14,606.51
=$75,369.86.-------------(A)
Lease:
Lease payment=$29,000
Lease payment after tax advantage=$29000*(1-.2)
=$23,200
Present value of lease payments over the three years=$23,200*2.577
=$59,788.65.------------(B)
Net advantage is to lease than purchasing.
The amount of the adavantage=(A)-(B)
=$15,581.21.
Year Depreciation rate Depreciation Tax savings on depreciation Present value factor @8% Present value 1 0.33 33000 6600 0.925925926 6111.111111 2 0.45 45000 9000 0.85733882 7716.049383 3 0.15 15000 3000 0.793832241 2381.496723 Total 16208.65722Related Questions
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