Question
Smith company is conducting a lease analysis on some assembly line equipment that it will procure in the coming year. The following data have been
Smith company is conducting a lease analysis on some assembly line equipment that it will procure in the coming year. The following data have been developed.
• Smith plans to acquire an automated assembly line with a 10-year life and a cost of $10 million, delivered and installed. However, Smith plans to use the equipment for only 5 years, for it will discontinue the product line at that time. • Smith can borrow the required $10 million at an after-tax cost of 10%.
• The equipment’s estimated salvage value is $50,000 after 10 years of use, but it is $1,000,000 after only 5 years of use.
• Smith can lease the equipment for 5 years at a rental charge of $2,750,000, payable at the beginning of each year, but the lessor will own the equipment upon the expiration of the lease.
• Depreciation rate is 0.2, 0.32, 0.19, 0.12 and 0.11 in years 1 through 5, respectively. • Smith’s corporate tax rate is 40%. Should Smith lease or borrow and buy the equipment?
Borrowing and buying (price in thousand $) | |||||||
Year | 0 | 1 | 2 | 3 | 4 | 5 | |
1 | purchase price | -10,000 | |||||
2 | dep tax savings | 800 | 1,280 | 760 | 480 | 440 | |
3 | Salvage | 1,000 | |||||
4 | Tax payable on sale | -160 | |||||
5 | Net cash flows | -10,000 | 800 | 1,280 | 760 | 480 | 1280 |
Cost of debt | 0.10 | ||||||
PV | -10,000 | 727 | 1,058 | 571 | 328 | 795 | |
NPV of borrow to buy | -$6,521.25 |
in this answer, i want to now how to caclulate the salvage is 1000 and
why the purchase price is -10000 |
Step by Step Solution
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There are 3 Steps involved in it
Step: 1
The salvage value of the equipment after 5 years of use is 1000000 This means that if Smith d...Get Instant Access to Expert-Tailored Solutions
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Step: 2
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