Andiola Corporation is evaluating whether to lease or purchase equipment. Its ta
ID: 2637999 • Letter: A
Question
Andiola Corporation is evaluating whether to lease or purchase equipment. Its tax rate is 30 percent. If the company purchases the equipment for $1,500,000 it will depreciate it over 5 years, using straight-line depreciation. If the company enters into a 5-year lease, the lease payment is $350,000 per year, payable at the beginning of each year. If the company purchases the equipment it will borrow from its bank at an interest rate of 10 percent.
a. Calculate the cost of purchasing the equipment.
b. Calculate the cost of leasing the equipment.
c. Calculate the net advantage to leasing. Should the company purchase or lease the equipment?
b. Calculate the cost of leasing the equipment.
c. Calculate the net advantage to leasing. Should the company purchase or lease the equipment?
Explanation / Answer
Loan amortization schedule Cost of equipment 1,500,000 Year Beginning Annual payment Interest payment Principal payment Ending balance After tax discount rate 7.00% Annual loan payment ($395,696.22) 1 1500000 ($395,696.22) 150000 ($245,696.22) $1,254,303.78 Annual depreciation 300,000 2 $1,254,303.78 ($395,696.22) 125430.38 ($270,265.84) $984,037.94 3 $984,037.94 ($395,696.22) 98403.794 ($297,292.43) $686,745.51 Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 4 $686,745.51 ($395,696.22) 68674.551 ($327,021.67) $359,723.84 Interest -150000 -125430.3779 -98403.79355 -68674.55079 -35972.38374 5 $359,723.84 ($395,696.22) 35972.384 ($359,723.84) ($0.00) Annual depreciation $ (300,000.00) $ (300,000.00) $ (300,000.00) $ (300,000.00) $ (300,000.00) Total $ (450,000.00) $ (425,430.38) $ (398,403.79) $ (368,674.55) $ (335,972.38) Taxes $ (135,000.00) $ (127,629.11) $ (119,521.14) $ (110,602.37) $ (100,791.72) After tax cash flow $ (315,000.00) $ (297,801.26) $ (278,882.66) $ (258,072.19) $ (235,180.67) Annual loan repayment (245,696) (270,266) (297,292) (327,022) (359,724) Total (560,696) (568,067) (576,175) (585,094) (594,905) Present value (524,015) (496,172) (470,330) (446,365) (424,159) Total cost (2,361,041) Altenate method Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Interest ($150,000) ($150,000) ($150,000) ($150,000) ($150,000) Annual depreciation $ (300,000.00) $ (299,999.00) $ (299,998.00) $ (299,997.00) $ (299,996.00) Total $ (450,000.00) $ (449,999.00) $ (449,998.00) $ (449,997.00) $ (449,996.00) Taxes $ (135,000.00) $ (134,999.70) $ (134,999.40) $ (134,999.10) $ (134,998.80) After tax cash flow $ (315,000.00) $ (314,999.30) $ (314,998.60) $ (314,997.90) $ (314,997.20) Loan repayment - - - - (1,500,000) Total (315,000) (314,999) (314,999) (314,998) (1,814,997) Present value (294,393) (275,133) (257,133) (240,310) (1,294,068) Total cost (2,361,036) b. Calculate the cost of leasing the equipment with debt. Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Annual lease payment ($350,000) ($350,000) ($350,000) ($350,000) ($350,000) Taxes ($105,000) ($105,000) ($105,000) ($105,000) ($105,000) After-tax cash flow ($245,000) ($245,000) ($245,000) ($245,000) ($245,000) Present value (245,000) (228,972) (213,992) (199,993) (186,909) Total cost (1,074,867) NAL 1,286,175 NAL using alternative emthod 1,286,169 Using both methods it is clear that leasing is preferred over purchases as the company can save more cost by leasing when compared to purchases.