COMPARING TRACTOR FINANCING OPTIONS After land, machinery is often the largest single investment on a farm. Many dollars can be saved by carefully exploring all options for acquiring its use. The objective of this exercise is to compare three different plans for financing the purchase of a new tractor Financing Options A new tractor can be acquired by: 1. Outright purchase for cash, at a cost of $64,500. 2. Purchase by an installment contract with a down payment of 20 % of the purchase price and four equal annual payments, with a 7.5 % annual interest rate 3. A four-year lease plan with annual payments of $12,250 followed by a purchase at a buyout price of $30,000. Discounting future payments to their present value allows you to directly compare the financing plans. Each future payment is converted to a present value by dividing it by (1 +the discount rate) for each year into the future that it occurs. Assume your average cost of capital, minus inflation, is 6%, so you would use a factor of 1.06 per year to discount future payments to their I present value For example: Future payment $10,000 three years from now Present value $10.000(1.06x 1.06 x 1.06) $10,000/(1.06)3 $8,396 Alternative 1. Purchase tractor outright. There is no need to discount the payment, since it is made at the time of purchase. Purchase price $ Alternative 2. Pay 20 percent of the purchase price down and finance the remainder with 4 annual payments, beginning in one year. The amortization factor for a 4-year, 7.5 % interest loan is 29857 Annual paymcnt purchase price x 80% x amortization factor Present value Discount factor S before discounting 1.00 $ Down payment 1.06 $ 1st payment (in 1 year) (1.06)2 2nd payment (in 2 yxs) / (1.06)3 3rd payment (in 3 yrs) 4th payment (in 4 yrs) $ (1.06)4 Total *Round values to the near whole dollar I Alternative 3. Lease the tractor for 4 years, then purchase it for the buyout price (see Table 1) Lease payments are due at the beginning of each year S before discounting Present value Discount factor 1.00 1st payment (now) 2nd payment (in 1 year) S 1.06 3rd payment (in 2 yrs) (1.06)2 (1.06)3 (1.06)4 4th payment (in 3 yrs) S Buyout price (in 4 yrs) Total $ Comparison Under which plan do you pay the most total dollars, before discounting? I Which alternative plan has the lowest present value, after discounting? Which has the lowest payment at the time of purchase? Which financing alternative would you choose, and why