To finance some manufacturing tools it needs for the next 4 years, Waldrop Corpo
ID: 2628840 • Letter: T
Question
To finance some manufacturing tools it needs for the next 4 years, Waldrop Corporation is considering a leasing arrangement. Waldrop Corporation has no use for the machine beyond the expiration of the lease, and the machine has an estimated residual value of $250,000 at the end of the 4th year. The machinery falls into the MACRS 3-year class. The MACRS allowance factors are 0.3333, 0.4445, 0.1481, and 0.0741 for Year 1, 2, 3, 4, respectively. It can borrow $1.52 million, the purchase price, at an interest rate of 15% and buy the tools, or it can make four (4) equal end-of-year lease payments of $400,000 each and lease them. The loan obtained from the bank is a 4-year simple interest loan, with interest paid at the end of each year for four years and the principal repaid at Year 4. The firm's tax rate is 40%. Under either the lease or the purchase, Waldrop Corporation must pay for insurance, property taxes, and maintenance. What is the net advantage to leasing (NAL)?
Explanation / Answer
Present value of loan Option Year 0 1 2 3 4 Initial outlay -1,520,000.00 Depreciation 506,616.00 675,640.00 225,112.00 112,632.00 Depreciation tax benefit 202,646.40 270,256.00 90,044.80 45,052.80 Residual value 150,000.00 Net benefir from loan -1,520,000.00 202,646.40 270,256.00 90,044.80 195,052.80 -968,564.42 PV factor 1.00 0.87 0.76 0.66 0.57 -1,520,000.00 176,302.37 204,313.54 59,249.48 111,570.20 Present Value of leasing Annual payments -240,000.00 Rate of Interest 0.15 Period 4.00 Present Value 685,194.81 Leasing is better NAL = Present value of loan - present value of lease 283,369.61