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Sadik Industries must install $1 million of new machinery in its Texas plant. It can obtain a bank loan for 100% of the required 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 35%.

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 $220,000, 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 timeline, Sadik would show the cost of the used equipment at Year 3 and its depreciation expenses starting at Year 3.

Year3-year MACRS

1- 33.33%

2- 44.45%

3- 14.81%

4- 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 question below.

34 Interest tax savings 35 Depreciation tax savings 47 After-tax lease payment 48 Fair market value of machinery 49 Depreciation tax savings 50 Net cash ow 36 Net cash ow $0 $0 $0 $0 $0 $0 $05 37 l 38 PV of ownership i 39 i 40 i 41 Depreciation Schedule of Used Machinery- Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 i 42 Depreciation expense 43 Book value of used machinery 220,000 220,000 220,000 220,000! 44 : 45 i 46 Cost of Leasing Machinery.- Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 i I 51 i 52 oneasins a 53 i 54 Net advantage of leasing i 55 i 56 Should the rm lease the machinery? i i 57 Lease versus Buy AWNI Cost of machinery $1,000,000 Bank loan amount as % of cost 100.00% 5 6 MACRS Depreciation Rates: Year 1 Year 2 Year 3 Year 4 7 33.33% 44.45% 14.81% 7.41% Co 9 Estimated annual maintenance expenses $46,000 10 Length of lease term (in years) 3 11 Annual end-of-year lease payments $280,000 12 Lessee pays for insurance, property taxes, and maintenance Yes 13 Machinery fair market value at Year 3 $220,000 14 Firm's tax rate 35.00% 15 Bank loan rate 14.00% 16 Length of loan term (in years) for annual end-of-year payments 6 17 18 Borrow and Buy Analysis: 19 Depreciation Schedule of New Machinery: Year 1 Year 2 Year 3 Year 4 20 Depreciation expense $333,300 $444,500 $148, 100 $74, 100 Book value of new machinery $666,700 $222,200 $74, 100 $0 22 23 Amortization Schedule of Loan: Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 24 Beginning loan balance $1,000,000 $0 $0 $0 $0 $0 25 Loan payment 0 0 0 0 0 26 Interest payment 27 Principal payment 28 Ending loan balance 29 30 Cost of Owning: Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 31 Purchase price of machinery 32 Loan proceeds 33 Loan payments 0 0 0 0 0