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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

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The salvage value of the equipment after 5 years of use is 1000000 This means that if Smith d... blur-text-image

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