To finance some manufacturing tools it needs for the next 4 years, Waldrop Corpo
ID: 2649128 • 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 $1.47 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 Costs under lease option
End-of-year lease payments (Net of Tax)
Present value of Costs under lease option
Present value of Costs under Purchase option
Total cost = A +B -C -D
Present value of Costs under Purchase option
Calculation of Net Advantage from lease (NAL) Discounting factor= Interest rate *(1-tax) = 15% * (1-0.40) =9%Present value of Costs under lease option
Year 0 Year 1 Year 2 Year 3 Year 4End-of-year lease payments (Net of Tax)
$ - $ 240,000.00 $ 240,000.00 $ 240,000.00 $ 240,000.00 400000* (1-0.40) PVF (9%) 1.000000 0.917431 0.841680 0.772183 0.708425 PV = Amount * PVF $ - $ 220,183.49 $ 202,003.20 $ 185,324.04 $ 170,022.05Present value of Costs under lease option
$ 777,532.77Present value of Costs under Purchase option
Year 0 Year 1 Year 2 Year 3 Year 4 Payament of loan Principal (A) $ 1,470,000.00 Payment of interest (Net of tax) (B) $ 132,300.00 $ 132,300.00 $ 132,300.00 $ 132,300.00 1470000*15% = 220500*(1-0.40) =132300 Tax Saving on depreciation : Depreciation factor 0.3333 0.4445 0.1481 0.0741 Depreciation =1470000* Dep. Factor $ 489,951.00 $ 653,415.00 $ 217,707.00 $ 108,927.00 Tax Saving on depreciation =Dep * 40% (C) $ 195,980.40 $ 261,366.00 $ 87,082.80 $ 43,570.80 Salvage value (Net of tax) =250000* (1-0.40) (D) $ 150,000.00Total cost = A +B -C -D
$ - $ (63,680.40) $ (129,066.00) $ 45,217.20 $ 1,408,729.20 PVF (9%) 1.000000 0.917431 0.841680 0.772183 0.708425 PV = Amount * PVF $ - $ (58,422.39) $ (108,632.27) $ 34,915.97 $ 997,979.28Present value of Costs under Purchase option
$ 865,840.60 Net Advantage from lease (NAL) $ 88,307.83 Purchase option cost - Lease option cost = 865840.6 - 777532.77