Delmont Transport Company (DTC) is evaluating the merits of leasing versus purch

Question

Delmont Transport Company (DTC) is evaluating the merits of leasing versus purchasing a truck with a 4-year life that costs $40,000 and falls into the MACRS 3-year class. If the firm borrows and buys the truck, the loan rate would be 10%, and the loan would be amortized over the truck's 4-year life, so the interest expense for taxes would decline over time. The loan payments would be made at the end of each year. The truck will be used for 4 years, at the end of which time, it will be sold at an estimated residual value of $10,000. If DTC buys the truck, it would purchase a maintenance contract that costs $1,000 per year, payable at the end of each year. The lease terms, which include maintenance, call for a $10,000 lease payment at the beginning of each year (i.e. 4 payments total). DTC's tax rate is 40%.

What is the net advantage to leasing?

           (Note: Assume MACRS rates for Years 1 to 4 are 0.3333, 0.4445, 0.1481, and 0.0741.)

Please show work and charts. Thank you

Explanation / Answer

cost of purchase Formulas year principle payments interest payments taxes on interest pay ments Depreciation taxes on depreciation maintenance resale cost principle payments interest payments 1 ($8,618.83) ($4,000.00) ($1,600.00) 13200 5280 1000 ($6,738.83) PPMT(0.1,1,4,40000) IPMT(0.1,1,4,40000) 2 ($9,480.72) ($3,138.12) ($1,255.25) 18000 7200 1000 ($5,163.59) 3 ($10,428.79) ($2,190.05) ($876.02) 6000 2400 1000 ($10,342.81) 4 ($11,471.67) ($1,147.17) ($458.87) 2800 1120 1000 10000 ($2,039.97) Total ($40,000.00) ($10,475.33) ($4,190.13) 40000 16000 4000 10000 ($24,285.20) PV of cost of purchase = ($16,587.12) PV(0.1,4,,24285.2) cost of lease 10000 *4 = 40000 less: taxes on lease 16000 (0.4*400000) = 24000 PV of lease ($16,392.32) PV(0.1,4,,24000) Adv of lease = PV of purchase - PV of lease 194.8 There fore Delmont should lease the truck

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