a.

$___________

Since the cost of leasing the machinery is _________ than the cost of owning it,

1. less 2.greater

the firm should _______ the equipment.

1. lease 2. buy

B. The decision almost can be considered a bet on the future residual value. Do you think the residual cash flows are equal in risk to the other cash flows? (Hint: if you discount a negative cash flow at a higher rate, you get a better NPV the NPV of a negative cash flow stream is less negative at high discount rates.)

1. Yes 2. No

Sadik Industries must install $1 million of new machinery in its Texas plant. It can obtain a bank loan for 100% of the equired amount. Alternatively, a Texas investment banking firm that represents a group of investors believes that it can arrange for a lease financing plan. Assume that these facts apply: 1. The equipment falls in the MACRS 3-year class 2. Estimated maintenance expenses are $46,000 per year 3 The firm's tax rate is 40%. 4. If the money is borrowed, the bank loan will be at a rate of 14%, amortized in six equal installments at the end of each year 5. The tentative lease terms call for payments of $280,000 at the end of each year for 3 years. The lease is a guideline lease 6. Under the proposed lease terms, the lessee must pay for insurance, property taxes, and maintenance 7. Sadik must use the equipment if it is to continue in business, so it will almost certainly want to acquire the property at the end of the lease. If it does, then under the lease terms it can purchase the machinery at its fair market value at Year 3. The best estimate of this market value is $240,000, but it could be much higher or lower under certain circumstances. If purchased at Year 3, the used equipment would fall into the MACRs 3-year class. Sadik would actually be able to make the purchase on the last day of the year (i.e., slightly before Year 3), so Sadik would get to take the first depreciation expense at Year 3 (the remaining depreciation expenses would be at Year 4 through Year 6). On the time line, Sadik would show the cost of the used equipment at Year 3 and its depreciation expenses starting at Year 3. Year 3-year MACRS 33.33 % 44.45 % 14.81 % 7.41 % The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions below Open spreadsheet To assist management in making the proper lease-versus-buy decision, you are asked to answer the following questions: a. What is the net advantage of leasing? Should Sadik take the lease? Do not round intermediate calculations. Round your answer to the nearest dollar Net advantage of leasing $ Since the cost of leasing the machinery istan the cost of owning it, the firm shouldhe equipent. b. The decision almost can be considered a bet on the future residual value. Do you think the residual cash flows are equal in risk to the other cash flows? (Hint: if you discount a negative cash flow at a higher rate, you get a better NPV the NPV of a negative cash flow stream is less negative at high discount rates.) 1 Lease versus Buv 3 Cost of machinerv 4 Bank loan amount as % of cost $1.000.000 100.00% 6MACRS Depreciation Ra 7 33% 44.45% 14.81% 7.41% $46.000 9 10 11 12 13 14 15 16 Estimated annual maintenance exDenses Lenath of lease term (in vears) Annual end-of-vear lease pavments Lessee pavs for insurance. propertv taxes. and m Machinery fair market value at Year 3 Firm's tax rate Bank loan rate Lenath of loan term (in vears) for annual end-of-v $280.000 es $240,000 40.00% 14.00% 18 Borrow and Buv Analvsis: 19 Deoreciation Schedule of New Machinerv 20 Depreciation expense 21 Book value of new machinerv $1.000.000 $1.000.000$1.000.000$1.000.0 23 24 25 26 27 28 Amortization Schedule of L Beainnina loan balance Loan pavment Interest pavment Principal pavment Endina loan balance $1.000 30 31 32 33 34 35 36 Cost of Ownina Purchase price of machinerv Loan proceeds Loan pavments Interest tax savinas Depreciation tax savinas Net cash flow 38 PV of ownershio 41 Deoreciation Schedule of Used Machinerv 42 Depreciation expense 43 Book value of used machinerv 240.000 240.000 240.000 240.000 46 Cost of Leasina Machinerv: 47 After-tax lease pavment 48 Fair market value of machinerv 49 DepDreciation tax savinas S0 t cash flow PV of leasina Net advantaae of leasina 51 52 54 56 Should the firm lease the machinerv? 59 Borrow and Buv Analvsis: 60 Deoreciation Schedule of New Machinerv 61 Depreciation expense 62 Book value of new machinerv 64 65 66 67 68 69 Amortization Schedule of L Beainnina loan balance Loan pavment Interest pavment Principal oavment Endina loan balance #N/A MVA #N/A #N/A #N/A #N/A #N/A AVA AVA 71 72 73 74 75 76 77 Cost of Ownina Purchase price of machinerv Loan Droceeds Loan pavments Interest tax savinas Depreciation tax savinas #N/A #N/A #NIA #N/A Net cash flow 79 PV of ownershiD 82 83 84 Deoreciation Schedule of Used Machinerv. Depreciation expense Book value of used machinerv 87 88 Cost of Leasina Machinerv: After-tax lease pavment Sheet1 86 87 Cost of Leasina Machinerv: 88 After-tax lease pavment 89 Fair market value of machinerv 90 Depreciation tax savinas 91 Net cash flow 92 93 PV of leasina 94 95 Net advantaae of leasina 96 97 Should the firm lease the machinerv? 98 #NIA #N/A #N/A #N/A #N/ 100 101 Sadik Industries must install $1 million of new machinery in its Texas plant. It can obtain a bank loan for 100% of the equired amount. Alternatively, a Texas investment banking firm that represents a group of investors believes that it can arrange for a lease financing plan. Assume that these facts apply: 1. The equipment falls in the MACRS 3-year class 2. Estimated maintenance expenses are $46,000 per year 3 The firm's tax rate is 40%. 4. If the money is borrowed, the bank loan will be at a rate of 14%, amortized in six equal installments at the end of each year 5. The tentative lease terms call for payments of $280,000 at the end of each year for 3 years. The lease is a guideline lease 6. Under the proposed lease terms, the lessee must pay for insurance, property taxes, and maintenance 7. Sadik must use the equipment if it is to continue in business, so it will almost certainly want to acquire the property at the end of the lease. If it does, then under the lease terms it can purchase the machinery at its fair market value at Year 3. The best estimate of this market value is $240,000, but it could be much higher or lower under certain circumstances. If purchased at Year 3, the used equipment would fall into the MACRs 3-year class. Sadik would actually be able to make the purchase on the last day of the year (i.e., slightly before Year 3), so Sadik would get to take the first depreciation expense at Year 3 (the remaining depreciation expenses would be at Year 4 through Year 6). On the time line, Sadik would show the cost of the used equipment at Year 3 and its depreciation expenses starting at Year 3. Year 3-year MACRS 33.33 % 44.45 % 14.81 % 7.41 % The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions below Open spreadsheet To assist management in making the proper lease-versus-buy decision, you are asked to answer the following questions: a. What is the net advantage of leasing? Should Sadik take the lease? Do not round intermediate calculations. Round your answer to the nearest dollar Net advantage of leasing $ Since the cost of leasing the machinery istan the cost of owning it, the firm shouldhe equipent. b. The decision almost can be considered a bet on the future residual value. Do you think the residual cash flows are equal in risk to the other cash flows? (Hint: if you discount a negative cash flow at a higher rate, you get a better NPV the NPV of a negative cash flow stream is less negative at high discount rates.) 1 Lease versus Buv 3 Cost of machinerv 4 Bank loan amount as % of cost $1.000.000 100.00% 6MACRS Depreciation Ra 7 33% 44.45% 14.81% 7.41% $46.000 9 10 11 12 13 14 15 16 Estimated annual maintenance exDenses Lenath of lease term (in vears) Annual end-of-vear lease pavments Lessee pavs for insurance. propertv taxes. and m Machinery fair market value at Year 3 Firm's tax rate Bank loan rate Lenath of loan term (in vears) for annual end-of-v $280.000 es $240,000 40.00% 14.00% 18 Borrow and Buv Analvsis: 19 Deoreciation Schedule of New Machinerv 20 Depreciation expense 21 Book value of new machinerv $1.000.000 $1.000.000$1.000.000$1.000.0 23 24 25 26 27 28 Amortization Schedule of L Beainnina loan balance Loan pavment Interest pavment Principal pavment Endina loan balance $1.000 30 31 32 33 34 35 36 Cost of Ownina Purchase price of machinerv Loan proceeds Loan pavments Interest tax savinas Depreciation tax savinas Net cash flow 38 PV of ownershio 41 Deoreciation Schedule of Used Machinerv 42 Depreciation expense 43 Book value of used machinerv 240.000 240.000 240.000 240.000 46 Cost of Leasina Machinerv: 47 After-tax lease pavment 48 Fair market value of machinerv 49 DepDreciation tax savinas S0 t cash flow PV of leasina Net advantaae of leasina 51 52 54 56 Should the firm lease the machinerv? 59 Borrow and Buv Analvsis: 60 Deoreciation Schedule of New Machinerv 61 Depreciation expense 62 Book value of new machinerv 64 65 66 67 68 69 Amortization Schedule of L Beainnina loan balance Loan pavment Interest pavment Principal oavment Endina loan balance #N/A MVA #N/A #N/A #N/A #N/A #N/A AVA AVA 71 72 73 74 75 76 77 Cost of Ownina Purchase price of machinerv Loan Droceeds Loan pavments Interest tax savinas Depreciation tax savinas #N/A #N/A #NIA #N/A Net cash flow 79 PV of ownershiD 82 83 84 Deoreciation Schedule of Used Machinerv. Depreciation expense Book value of used machinerv 87 88 Cost of Leasina Machinerv: After-tax lease pavment Sheet1 86 87 Cost of Leasina Machinerv: 88 After-tax lease pavment 89 Fair market value of machinerv 90 Depreciation tax savinas 91 Net cash flow 92 93 PV of leasina 94 95 Net advantaae of leasina 96 97 Should the firm lease the machinerv? 98 #NIA #N/A #N/A #N/A #N/ 100 101