Carmichael Cleaners needs a new steam finishing machine that costs $100,000. The
ID: 2451817 • Letter: C
Question
Carmichael Cleaners needs a new steam finishing machine that costs $100,000. The company is evaluating whether it should lease or purchase the machine. The equipment falls into the MACRS 3-year class, and it would be used for 3 years and then sold, because the firm plans to move to a new facility at that time. The estimated value of the equipment after 3 years is $30,000. A maintenance contract on the equipment would cost $3,000 per year, payable at the beginning of each year. Alternatively, the firm could lease the equipment for 3 years for a lease payment of $29,000 per year, payable at the beginning of each year. The lease would include maintenance. The firm is in the 20% tax bracket, and it could obtain a 3-year simple interest loan, interest payable at the end of the year, to purchase the equipment at a before-tax cost of 10%. (Note: MACRS rates for Years 1 to 4 are 0.3333, 0.4445, 0.1481, and 0.0741.)
Question1: What is the principal repayment in Year 2?
a. $33,233
b. $0
c. $6,979
d. $10,000
Question2: What is the after-tax interest payment in Year 3?
a. $8,000
b. $2,924
c. $3,656
d. $6,000
Question3: How much is the after-tax salvage value at the end of Year 3 if Carmichael Cleaners buys the machine?
a. $20,964
b. $24,000
c. $30,000
d. $25,482
Question4: Should Carmichael Cleaners buy or lease the machine?
a. Buy, the net advantage to leasing is $5,734
b. Lease, the net advantage to leasing is $5,734
c. Buy, the net advantage to leasing is $4,822
d. Lease, the net advantage to leasing is $4,822
Explanation / Answer
Answer 1. Since rloan will be repaid at the end of the 3years therefore no repayment shall be made at the end of 2nd year.
Thus answer will be (b)
Answer 2. Interes for 3rd year = 100000*10%(1-0.20) = $8000
Therefor answer will be (a)
Answer 3.
Depreciation for Ist year = 100000*33.33% =33330
Depreciation for IInd year = (100000-33330)*44.45% =29635
Depreciation for 3rd year = (100000-33330-29635)*14.81% = 5485
Book value at the end of 3rd year = 100000-33330-29635-5485 = 31550
loss on sale of assets = 1550
Thus, Scrap value after tax will remaim 30000 since no tax will be levied on loss.
Therefore answer will be (c)