assume a straight line depreciation of 25% year on year for 4 years

Question 2

Mini Case for Lease Financing Agricare Securities Inc, has decided to acquire a new market data and quotation system for its Richmond home office. The system receives current market prices and other information from several on-line data services, then either displays the information on a screen or stores it for later retrieval by the firm's brokers. The system also permits customers to call up current quotes on terminals in the lobby The equipment costs GHS 1,000,000, and, if it were purchased. Apricare could obtain a term loan for the full purchase price at a 10 percent interest rate. Although the equipment has a six-year useful life, it is classified as a special-purpose computer, soit falls into a straight-line depreciation if the system were purchased, a 4-year maintenance contract could be obtained at a cost of GHS 20,000 per year, payable at the beginning of each year. The equipment would be sold after 4 years, and the best estimate of its residual value at that time is GHS 200,000. However, since real-time display system technology is changing rapidly, the actual residual value is uncertain 1 As an alternative to the borrow-and-buy plan, the equipment manufacturer informed Agricare that Consolidated Leasing would be willing to write a 4-year guideline lease on the equipment, including maintenance, for payments of GHS 260,000 at the beginning of each year. Agricare's marginal federal-plus-state tax rate is 40 percent. The depreciation rate of the asset is given below: You have been asked to analyze the lease-versus-purchase decision, and in the process to answer the following questions: Question 1 Who are the two parties to a lease transaction? il What are the four primary types of leases, and what are their characteristics? i. How are leases classified for tax purposes? iv. What effect does leasing have on a firm's capital structure? Question 2 a) What is the present value cost of owning the equipment? (Hint: Set up a time line which shows the net cash flows over the period t=0 tot = 4 and then find the PV of these net cash flows, or the PV cost of owning) a. Explain the rationale for the discount rate you used to find the PV. b) What is Agricare's present value cost of leasing the equipment? (Hint: Again, construct a timeline.) c) What is the net advantage to leasing (NAL)? Does your analysis indicate that Agricare should buy or lease the equipment? Explain. d) Now assume that the equipment's residual value could be as low as GHS O or as high as GHS 400,000, but that GHS 200,000 is the expected value. Since the residual value is riskier than the other cash flows in the analysis, this differential risk should be incorporated into the analysis Describe how this could be accomplished. (No calculations are necessary but explain how you would modify the analysis it calculations were required.) What effect would increase uncertainty about the residual value have on Agricare's lease versus-purchase decision? Mini Case for Lease Financing Agricare Securities Inc, has decided to acquire a new market data and quotation system for its Richmond home office. The system receives current market prices and other information from several on-line data services, then either displays the information on a screen or stores it for later retrieval by the firm's brokers. The system also permits customers to call up current quotes on terminals in the lobby The equipment costs GHS 1,000,000, and, if it were purchased. Apricare could obtain a term loan for the full purchase price at a 10 percent interest rate. Although the equipment has a six-year useful life, it is classified as a special-purpose computer, soit falls into a straight-line depreciation if the system were purchased, a 4-year maintenance contract could be obtained at a cost of GHS 20,000 per year, payable at the beginning of each year. The equipment would be sold after 4 years, and the best estimate of its residual value at that time is GHS 200,000. However, since real-time display system technology is changing rapidly, the actual residual value is uncertain 1 As an alternative to the borrow-and-buy plan, the equipment manufacturer informed Agricare that Consolidated Leasing would be willing to write a 4-year guideline lease on the equipment, including maintenance, for payments of GHS 260,000 at the beginning of each year. Agricare's marginal federal-plus-state tax rate is 40 percent. The depreciation rate of the asset is given below: You have been asked to analyze the lease-versus-purchase decision, and in the process to answer the following questions: Question 1 Who are the two parties to a lease transaction? il What are the four primary types of leases, and what are their characteristics? i. How are leases classified for tax purposes? iv. What effect does leasing have on a firm's capital structure? Question 2 a) What is the present value cost of owning the equipment? (Hint: Set up a time line which shows the net cash flows over the period t=0 tot = 4 and then find the PV of these net cash flows, or the PV cost of owning) a. Explain the rationale for the discount rate you used to find the PV. b) What is Agricare's present value cost of leasing the equipment? (Hint: Again, construct a timeline.) c) What is the net advantage to leasing (NAL)? Does your analysis indicate that Agricare should buy or lease the equipment? Explain. d) Now assume that the equipment's residual value could be as low as GHS O or as high as GHS 400,000, but that GHS 200,000 is the expected value. Since the residual value is riskier than the other cash flows in the analysis, this differential risk should be incorporated into the analysis Describe how this could be accomplished. (No calculations are necessary but explain how you would modify the analysis it calculations were required.) What effect would increase uncertainty about the residual value have on Agricare's lease versus-purchase decision