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:

The equipment falls in the MACRS 3-year class.

Estimated maintenance expenses are $54,000 per year.

The firm's tax rate is 32%.

If the money is borrowed, the bank loan will be at a rate of 13%, amortized in six equal installments at the end of each year.

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.

Under the proposed lease terms, the lessee must pay for insurance, property taxes, and maintenance.

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 $150,000, 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 time line, Sadik would show the cost of the used equipment at Year 3 and its depreciation expenses starting at Year 3.

Year 3-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 questions below.

Open spreadsheet

To assist management in making the proper lease-versus-buy decision, you are asked to answer the following questions:

What is the net advantage of leasing? Should Sadik take the lease? Do not round intermediate calculations. Round your answer to the nearest dollar.

Net advantage of leasing $ fill in the blank 2

Since the cost of leasing the machinery is than the cost of owning it, the firm should the equipment.

The decision almost can be considered a bet on the future residual value. Do you think the residual cash flows are equal in risk to the other cash flows? (Hint: if you discount a negative cash flow at a higher rate, you get a better NPV the NPV of a negative cash flow stream is less negative at high discount rates.)

A versus Buy $1,000,000 100.00% Cost of machinery Bank loan amount ase of cost Year 2 44 45% Yeart 33.33% Yo 4 7.41% Year 3 1481% MACRS Depreciation Rates $54,000 Estimated annual maintenance expenses Length of tease term in yours) Annual end-of-year lease payments Lessee pays for insurance property taxes and maintenance Machinery fair market value at Year 3 Firm's tax rate Bank loan rate Length of loan term (in years) for annua end-of-year payments 7 8 Borrow and Buy Analysis: 19 Depreciation Schedule of New Machinery 20 Depreciation expense 21 Book value of new machinery $280,000 Yes $150,000 32.00% 1300% 6 Year 4 Year 2 Years $1,000,000 $1,000,000 $1.000.000 $1,000,000 Year 51 000 000 Year 2 SO Years SO Year 4 So Years SO 0 Years SO O 23 Amortization Schedule of Loan 14 Beginning loan balance 25 Loan payment 26 trest payment 27 Principal payment 28 Ending loan balance Year 4 Years Yhar Years Year Year C 0 0 30 Cost of Owning 31 Purchase price of machinery 32 Loan pieds 33 Loan payments interest saving 35 Depreciation tax saving Netchtow 32 50 So 50 50 50 So Sheet D F G H Your 0 Year: Year 2 Years Year 4 Years Year - 150.000 150.000 150,000 150,000 37 36 PV of ownership 39 40 41 Depreciation Schedule of Led Michinery 42 Depreciation expense 43 Book value of used machinery 44 5 46 Cost of Leasing Machinery 47 Alter-tax lase payment 48 Fair market value of machinery 49 Depreciation tax savings 50 Not cash now 51 PV of sing 33 5 Net advantage of losing Year Year Year 2 SO Year Your 4 Years You 6 $0 so $0 30 So 50 50 SO 56 Should the firm in the machinery Formule 9 Borrow and Buy Analysis: 00 Deprecation Schedule of New Machinery 61 Deprecato open 2 Book of vw machinery Vaa ANIA Yen UNIA Voo NA Ya 4 WNIA Year Ya var Yaar Year Yur 64 Amortization Schedule of loan Beginning once Loan payment were payment Pre payment s tingian blonde WA WA WNA NA INIA NA HNIA WNA NA ANA NA WNIA NA ANTA WNIA ANIA LA WA Year NA Year You 2 Year Years 71 Cost of Owning 72 Purchase price of machinery Loan proces B Sheet Years MNIA D E G WNIA HNIA WNIA I'NA UNIA INA NA WNIA WNIA INVA WNIA NA INJA LA INA INUA ob Loan payment 67 Interest payment 68 Principal payment 69 Ending loan balance 70 71 Cost of Owning 72 Purchase price of machinery 73 Loan proceeds 74 Loan payments 75 interest tax savings 70 Depreciation tax savings 77 Nel cash flow Yeart Year 2 Year Year 4 You Years Year o WNIA INIA WNIA WNIA WNIA N/A INJA ONIA WNIA MNIA WALIA ANA NA LA ONIA Year Year Year 2 Year 3 WNIA Year 4 ANIA Year Year NA Year o Year 2 Year 1 NA Year Years 79 PV of ownership 80 81 82 Depreciation Schedule of Lised Machinery 83 Depreciation expense 04 Book value of used machinery BS 86 Cost of Leasing Machinerys 88 Afer-tax loase payment 89 Fair market value of machinery 90 Depreciation tax savings 91 Niat cash flow 92 93 PV of losing 94 93 Net advantage of learning 96 97 Should them the machinery? Years ANIA MNIA NA NA NA WNA UA WNIA A versus Buy $1,000,000 100.00% Cost of machinery Bank loan amount ase of cost Year 2 44 45% Yeart 33.33% Yo 4 7.41% Year 3 1481% MACRS Depreciation Rates $54,000 Estimated annual maintenance expenses Length of tease term in yours) Annual end-of-year lease payments Lessee pays for insurance property taxes and maintenance Machinery fair market value at Year 3 Firm's tax rate Bank loan rate Length of loan term (in years) for annua end-of-year payments 7 8 Borrow and Buy Analysis: 19 Depreciation Schedule of New Machinery 20 Depreciation expense 21 Book value of new machinery $280,000 Yes $150,000 32.00% 1300% 6 Year 4 Year 2 Years $1,000,000 $1,000,000 $1.000.000 $1,000,000 Year 51 000 000 Year 2 SO Years SO Year 4 So Years SO 0 Years SO O 23 Amortization Schedule of Loan 14 Beginning loan balance 25 Loan payment 26 trest payment 27 Principal payment 28 Ending loan balance Year 4 Years Yhar Years Year Year C 0 0 30 Cost of Owning 31 Purchase price of machinery 32 Loan pieds 33 Loan payments interest saving 35 Depreciation tax saving Netchtow 32 50 So 50 50 50 So Sheet D F G H Your 0 Year: Year 2 Years Year 4 Years Year - 150.000 150.000 150,000 150,000 37 36 PV of ownership 39 40 41 Depreciation Schedule of Led Michinery 42 Depreciation expense 43 Book value of used machinery 44 5 46 Cost of Leasing Machinery 47 Alter-tax lase payment 48 Fair market value of machinery 49 Depreciation tax savings 50 Not cash now 51 PV of sing 33 5 Net advantage of losing Year Year Year 2 SO Year Your 4 Years You 6 $0 so $0 30 So 50 50 SO 56 Should the firm in the machinery Formule 9 Borrow and Buy Analysis: 00 Deprecation Schedule of New Machinery 61 Deprecato open 2 Book of vw machinery Vaa ANIA Yen UNIA Voo NA Ya 4 WNIA Year Ya var Yaar Year Yur 64 Amortization Schedule of loan Beginning once Loan payment were payment Pre payment s tingian blonde WA WA WNA NA INIA NA HNIA WNA NA ANA NA WNIA NA ANTA WNIA ANIA LA WA Year NA Year You 2 Year Years 71 Cost of Owning 72 Purchase price of machinery Loan proces B Sheet Years MNIA D E G WNIA HNIA WNIA I'NA UNIA INA NA WNIA WNIA INVA WNIA NA INJA LA INA INUA ob Loan payment 67 Interest payment 68 Principal payment 69 Ending loan balance 70 71 Cost of Owning 72 Purchase price of machinery 73 Loan proceeds 74 Loan payments 75 interest tax savings 70 Depreciation tax savings 77 Nel cash flow Yeart Year 2 Year Year 4 You Years Year o WNIA INIA WNIA WNIA WNIA N/A INJA ONIA WNIA MNIA WALIA ANA NA LA ONIA Year Year Year 2 Year 3 WNIA Year 4 ANIA Year Year NA Year o Year 2 Year 1 NA Year Years 79 PV of ownership 80 81 82 Depreciation Schedule of Lised Machinery 83 Depreciation expense 04 Book value of used machinery BS 86 Cost of Leasing Machinerys 88 Afer-tax loase payment 89 Fair market value of machinery 90 Depreciation tax savings 91 Niat cash flow 92 93 PV of losing 94 93 Net advantage of learning 96 97 Should them the machinery? Years ANIA MNIA NA NA NA WNA UA WNIA