Question
The problem below allows you to demonstrate your understanding of these concepts. A company needs to expand its facilities. To do so, the firm must
The problem below allows you to demonstrate your understanding of these concepts.
A company needs to expand its facilities. To do so, the firm must acquire a machine costing $80,000. The machine can be leased or purchased. The firm is in the 25% tax bracket, and its after-tax cost of debt is 9%. The terms of the lease and purchase plans are as follows:
Lease. The leasing arrangement requires end-of-year payments of $19,800 over 5 years. All maintenance costs will be paid by the lessor; insurance and other costs will be borne by the lessee. The lessee will exercise its option to purchase the asset for $24,000 at the termination of the lease.
Purchase. If the firm purchases the machine, its cost of $80,000 will be financed with a 5-year, 10% loan requiring equal end-of-year payments. The machine will be depreciated under MACRS using a 5-year recovery period (depreciation rates of 20%, 32%, 19%, 12%, and 12%, respectively). The firm will pay $2,000 per year for a service contract that covers all maintenance costs; insurance and other costs will be borne by the firm. The firm plans to keep the equipment and use it beyond its 5-year recovery period. (Hint: solve for the annual end-of-year loan payment first.)
- Determine the after-tax cash outflows of the Company under each alternative.
- Find the present value of each after-tax cash outflow stream, using the after-tax cost of debt (9%) as your discount rate.
- Which alternativelease or purchasewould you recommend? Why?
- Determine After-Tax Cash Outflows for Lease and Purchase
Lease
After-tax cash outflows = Annual Lease*(1- tax rate) = x/year for 5 years plus purchase option amount in year 5 (year 5 totals the annual loan payment plus the purchase option amount).
Purchase
| Year | Loan Payment (1) | Maintenance (2) | Depreciation (3) | Interest at x% (4) | Total Deductions (2 + 3 + 4) (5) | Tax Shields [(Tax rate) (5)] (6) | After-Tax Cash Outflows [(1 + 2) - (6)] (7) |
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- Present Value of Cash Outflows Analysis
| End of Year | Lease After-Tax Cash Outflows | Purchase After-Tax Cash Outflows |
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| Present value of cash outflows at x% discount rate |
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The New Look Of Affordable Housing
Authors: Alvin Hope Johnson
1st Edition
979-8854852562
