3.3 - Assignment: Problem Set - Leasing

All these problems have to be solved in Excel. Please submit your Excel solutions file in the online course.

Quartz Corporation is a relatively new firm. Quartz has experienced enough losses during its early years to provide it with at least eight years of tax loss carry-forwards. Thus, Quartzs effective tax rate is zero. Quartz plans to lease equipment from New Leasing Company. The term of the lease is five years. The purchase cost of the equipment is $650,000. Assume straight line depreciation. New Leasing Company is in the 35 percent tax bracket. There are no transaction costs to the lease. Each firm can borrow at 7 percent.

What is Quartzs maximum lease price?

What is New Leasing Companys minimum lease price?

Explain why these reservation prices determine the negotiation range of the lease.

Raymond Rayon Corporation wants to expand its manufacturing facilities. Liberty Leasing Corporation has offered Raymond Rayon the opportunity to lease a machine for $1,500,000 for six years. The machine will be fully depreciated by the straight-line method. The corporate tax rate for Raymond Rayon is 25 percent, whereas Liberty Leasing has a corporate tax rate of 40 percent. Both companies can borrow at 8 percent. Assume lease payments occur at year-end. What is Raymonds reservation price? What is Libertys reservation price?

The Decision to Lease or Buy at Warf Computers

Warf Computers has decided to proceed with the manufacture and distribution of the virtual keyboard (VK) the company has developed. To undertake this venture, the company needs to obtain equipment for the production of the microphone for the keyboard. Because of the required sensitivity of the microphone and its small size, the company needs specialized equipment for production.

Nick Warf, the company president, has found a vendor for the equipment. Clapton Acoustical Equipment has offered to sell Warf Computers the necessary equipment at a price of $5 million. Because of the rapid development of new technology, the equipment falls in the three-year MACRS depreciation class. At the end of four years, the market value of the equipment is expected to be $600,000.

Alternatively, the company can lease the equipment from Hendrix Leasing. The lease contract calls for four annual payments of $1.3 million due at the beginning of the year. Additionally, Warf Computers must make a security deposit of $300,000 that will be returned when the lease expires. Warf Computers can issue bonds with a yield of 11 percent, and the company has a marginal tax rate of 35 percent.

Should Warf buy or lease the equipment?

4. Magna Charter has been asked to operate a Beaver bush plane for a mining company exploring north and west of Fort Liard. Magna will have a firm 1-year contract with the mining company and expects that the contract will be renewed for the 7-year duration of the exploration program. Magna has the following choices:

Purchase a plane for $1,000,000

Arrange for a 7-year operating lease from Stellar Leasing Company. Maintenance and insurance will be borne by Magna. Lease payments will be of equal amounts each year, and due in advance at the beginning of each year.

The plane falls in the 5-year class with respect to depreciation under the MACRS. Accordingly, the depreciation percentages are 20%, 32%, 19%, 12%, 11% and 6% respectively. The salvage value at the end of 7 years is estimated at $50,000.

Magnas pre-tax cost of debt is 10%. Magna has large tax-loss carry forwards; however, owing to AMT (Alternative Minimum Tax) provisions, its expected marginal tax rate is 20%. Stellar Leasing Co., on the other hand , is a highly profitable company and faces a marginal tax rate of 40%. Stellar can earn a pre-tax rate of return of 10% on investments of similar risk.

Evaluate the lease from the point of view of both Magna and Stellar assuming that the lease payment is $180,500. What is the range of lease payment that would acceptable from the Lessee and the Lessors view point.

Answer required in 36 hours.