Question 2: Wandar Beverages is negotiating a lease on a new piece of equipment

Question

Question 2: Wandar Beverages is negotiating a lease on a new piece of equipment that would cost S80,000.00 if purchased Wandar could obtain a 4-year amortized loan at a before-tax cost of borrowing of 12% per annum to purchase the equipment. The equipment falls into the MACRS 3-year class and it would be used for 4 years and then sold, because the firm plans to move to a new facility at that time. The estimated value of the equipment after 4 years is $5,000.00. A maintenance contract on the equipment would cost $4,000.00 per year and insurance premium would cost S2,000.00, both payable at the beginning of each year. Alternatively, the firm could lease the equipment for 4 years for a lease payment of $25,000.00 per year, payable at the beginning of each year. The firm is in the 30% tax bracket and its weighted average cost of capital is 14%. If there is a positive Net Advantage to Leasing (NAL) the firm will lease the equipment. Otherwise, it will buy it. What is the NAL? (Note: MACRS rates for Years 1 to 4 are 0.33. 0.45, 0.15, and 0.07 respectively) [Total: 20 marks]

Explanation / Answer

Calculation of loan P = r(PV)/ 1- (1+r)^-n, where P =Payment per year, PV = present value of loan and r = interest rate P= 0.12*80,000 / 1 - (1.12)^-3 P = 9,600/ 0.29 = $33,100 Principal Interest Payment Loan Balance 23500 9600 33100 56500 26320 6780 33100 30180 29479 3621 33100 Find the cash flow Year 0 Year 1 Year 2 Year 3 Year 4 Investment -80000 O&M -4000 -4000 -4000 -4000 Insurance -2000 -2000 -2000 -2000 Interest on loan -9600 -6780 -3621 Depreciation -26664 -35560 -11848 -5928 Salvage 5000 Cost after salvage -6000 -42264 -48340 -21469 -928 Tax advantage-30% -1800 -12679.2 -14502 -6440.7 -278.4 Out flow of expenses after tax -4200 -29584.8 -33838 -15028.3 -649.6 Principal payment -23500 -26320 -29479 Total out flow considering depreciation -4200 -26420.8 -24598 -32659.3 5278.4 NPV of out flow = -4200 - 26421/(1.14) - 24598/(1.14)^2- 32659/(1.14)^3 + 5278(1.14)^4 -4200 - 23176 - 24598/ 1.2996 - 32659/ 1.48 + 5278/ 1.69 = -4200 - 23176 - 18,927 - 22067 + 3123 = -65247 Depreciation rate 33.33% 44.45% 14.81% 7.41% Lease option Lease payment $ 25,000 at the beginning of year After tax out flow = 25,000 *70% = 17,500 NPV of lease payment = -17,500 ((1 - (1.14)^-4)/ 0.14)* 1.14 = -17,500 *3.317=- 58,048 NAL = -58,048 + 65247 = 7,200 So lease option is better option Slightly defference in calculation due to rounding

Related Questions

Navigate

• Browse (All)
• Browse Q
• Subjects

---

---

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