Glacier of Armenia is the largest independent ice maker facility in Armenia. Glacier provides ice to bars, restaurants, supermarkets, and food storage facilities, controlling 70% of the market for ice in Armenia. In 2013, Chairman and CEO of Glacier was considering options for acquiring 12 new commercial freezers needed for the commercial storage facilities. Since the corporate tax in Armenia was relatively low, Glacier could not fully take advantage of the equipment's depreciation tax shield. Hence Glacier was considering a fifteen-year lease of the freezers.

The investment arm of Farmers Insurance Group (FIG) had offered to structure a capital lease for Glacier in which FIG were to purchase the freezers from Polar King, a leading manufacturer, at $18 million and

immediately lease them to Glacier. FIG's required rate of return was 13.8%, effective tax rate was 27%, and US tax laws permitted FIG to depreciate the leased freezers with straight-line depreciation to the ending book value of $500,000 at the end of the lease period. The Armenian tax laws, however, only permitted Glacier, if bought the freezers, to depreciate the freezers under a 15-year straight-line plan to a book salvage value of zero.

The freezers needed to be insured with an annual insurance premium of $36,500 and required annual scheduled maintenance of $280,000. If Glacier leased the freezers, FIG would be responsible to cover insurance and maintenance costs as the owner of the freezers. If Glacier bought the freezers directly from Polar King, Glacier would be responsible for both insurance and maintenance costs. Moreover, both FIG and Glacier estimated that the freezers could be sold at $1.2 million at the end of the lease period (the salvage value after 15 years).

Glacier's effective tax rate was 17% in Armenia, pre-tax cost of debt (for borrowing the required funds to directly purchase the freezers from Polar King) was 18.7%, and the WACC was 26.7%.

In this project, you are to determine the before-tax annual lease payment that FIG should charge Glacier as well as whether Glacier should accept FIG's lease offer.

STEP 1: FIG's Before-Tax Annual Lease Payment

Develop an Excel spreadsheet model and determine FIG's amount to be amortized, before-tax, and after- tax annual lease payment. Label this tab "FIG". Then, answer the following question.

a) What is FIG's Lease contract offered to Glacier? (How much should Glacier pay every year?)

STEP 2: Glacier's Buy/Lease Decision

Develop an Excel spreadsheet model and determine Glacier's NAL. Title this tab "Glacier". Then, answer the following questions.

a) What is the NAL?

b) Do you think Glacier should lease the freezers?

Deliverables for Part II:

- Two spreadsheets for the two calculations: "FIG", "Glacier".

- Answer the questions above in your spreadsheet.