Hamlin Duplicating Company, Inc (HDC),

is a leading copying company in Fort

Myers, Florida. It was founded 22 years ago

by Skip and Marvin Hamlin. The brothers

had both had difficulty in college

duplicating class materials, so after they graduated,

they had the idea to found a business based on

duplicating materials for college courses.

This service was particularly useful for prof

essors who wished to

use their own materials

in classrooms or who required large quantit

ies of duplicated materials. Colleges and

universities encouraged

their professors to use Hamlins

services since students paid the

duplication expenses by purchasing ma

terials directly from Hamlin.

Hamlin also catered to local businesse

s by providing duplication of all kinds of

promotional materials. However, the commercial

side of the business

represented only 27

percent of revenue and 38 percent of income be

fore interest and taxes. Hamlin grew and

by 2000 had franchises in 97 locations.

In 2000, Skip Hamlin was considering the purchase of new duplicating machine

that would triple th

e duplicating speed of the comp

any. The new machine was also

capable of duplicating in multicolors, collat

ing, stapling, and binding. Skip estimated that

it would increase the firms revenue through

higher job productivity. The first years

added revenue was estimated to be $75,000; th

ereafter, revenues would increase by the

rate of inflation, 5 percent.

Since the machine could be programmed by

the operator and then left to complete

the job, only one fully trained operator would

be required to maintain the entire print

facility. Thus, purchase of th

e machine would save $79,000 in

salaries and benefits. The

capital budgeting analysis indicated that the pu

rchase of the machine had an internal rate

of return of 16.2 percent over four years. Si

nce the company used a 12.7 percent after-tax

cost of capital for projects of such low ris

k, the project clearly was worth undertaking.

The machine had an invoice price of

$1,250,000, including delivery, installation,

and training. The asset would be depreciated

over four years using MACRS (thus, annual

depreciation rates of 33, 45, 15, and 7 percen

t, respectively, were required). The net

financing required for the system, if Hamlin borrows the money, would be the purchase

price borrowed from South Florida Nationa

l Bank on a four-year amortized note. The

loan would carry an interest rate of 11.5

percent with annual pr

incipal and interest

payments. If Hamlin purchases the equi

pment, the manufacturer will provide

maintenance services for a fee of $75,000 per year.

The machine is expected to have a useful

life of six years at the rate at which

Hamlin will use it, and Marvin Hamlin is

concerned that the purchase will lock the

company into using equipment that will be obsolete in four years or less. Lease Plan, Inc.,

a leasing company, has a plan that allows a cl

ient to lease the duplicator for four years.

This lease requires and annual pa

yment of $425,000, payable at the

beginning

of the year,

and also provides for maintenance.

In four years, Lease Plan should be able

to sell the machine to a smaller company

that does not require leading-edge

equipment. The selling price

at the time is estimated to

be $65,000. Lease Plan views leasing as an altern

ative to lending the funds at 9 percent.

Lease Plan has a marginal ta

x rate of 38 percent. Hamli

n, however, is a much smaller

company, so its marginal tax rate is only 20 percent.

2

If you were Skip and Marvin Hamlin, would you purchase or lease the

equipment?

QUESTIONS

1.

Calculate the net present value of leasing th

e equipment (also known as the net advantage

of leasing) from the Hamlin brothers point of view. Do you recommend that Hamlin

purchase or lease the equipment?

2.

What lease payment would make Hamlin in

different between leasing and purchasing?

(

Hint:

you need to set the NPV of leasing calculated in part 1 equal to zero by changing

lease payments.)

3.

Skip Hamlin recognizes that the analysis is

influenced by the selection of the uncertain

salvage value of the duplicator in year 4.

The equipment could be worth the values

below. What is the highest, lowest, and e

xpected NPV of leasing using these data? What

is the effect of salvage value on the NPV of the lease? How does this information affect

your recommendation?

Salvage Value

Probability

$12,500 20

$65,000 50

$100,000 30

4.

Suppose you learned that Hamlins tax rate

was about to increase substantially. What

effect would this have on NPV of leasing?

5.

Interest rates have been very volatile lately.

Skip Hamlin thinks that rates could increase

to 12.5 percent or decrease to 10.5 percent with

in the next few weeks. He also expects the

lease payment to change if the interest ra

tes change. The table below illustrates his

expectations. Analyze the effects of potential

interest rate changes. What is the highest

and lowest NPV of leasing? (Maintain the tax rate and the salvage value at their most

likely levels.)

Interest Rate

Lease Payment

10.5% $400,000

11.5% $425,000

12.5% $450,000

6.

Evaluate the lease from Lease Plans point of

view. What is the NPV of the lease and

internal rate of return? (

Hint

: Cash flows from lease to Lease Plan will be exactly the

same as to Hamlin, but with opposite sign.

Also Lease Plan has a higher tax rate and

lower cost of debt.)

7.

At what lease payment does Lease Plan earn exactly 9 percent? (

Hint:

as in part 2, you

need to set the NPV of leasing equa

l to zero by changing lease payments.)

8.

What is the range of nego

tiation on the lease payment?