Patriot Welding is considering a leasing arrangement to finance some manufacturi
ID: 2674951 • Letter: P
Question
Patriot Welding is considering a leasing arrangement to finance some manufacturing tools that it needs for the next 3 years. The tools will be obsolete and worthless after 3 years. The firm will depreciate the cost of the tools on a straight-line basis over their 3-year life. It can borrow $4,800,000, the purchase price, at 10% and buy the tools, or it can make 3 equal end-of-year lease payments of $2,100,000 each and lease them. The loan obtained from the bank is a 3-year simple interest loan, with interest paid at the end of the year. The firm's tax rate is 40%. Annual maintenance costs associated with ownership are estimated at $240,000, but this cost would be borne by the lessor if it leases. What is the net advantage to leasing (NAL), in thousands?Explanation / Answer
0 Year
1 Year
2 Year
3 Year
Cost of owning
Net purchase price
($4,800)
Maintenance cost
($ 240)
($ 240)
($ 240)
Maintenance tax savings Line
2 ´ 0.4)
96
96
96
Depreciation
1,600
1,600
Depreciation tax savings
640
640
640
Net cash flow
($4,800)
496
496
496
PV cost of owning
($3,474.2)
Cost of leasing
($2,100)
($2,100)
($2,100)
Lease pmt tax savings
840
840
840
Net cash flow
($1,260
($1,260
($1,260
PV cost of leasing
($3,368.0)
Net advantage to leasing:
NAL = PV cost of owning - PV cost of leasing
= $3,474.2 - $3,368.0 = $106.2.
0 Year
1 Year
2 Year
3 Year
Cost of owning
Net purchase price
($4,800)
Maintenance cost
($ 240)
($ 240)
($ 240)
Maintenance tax savings Line
2 ´ 0.4)
96
96
96
Depreciation
1,600
1,600
Depreciation tax savings
640
640
640
Net cash flow
($4,800)
496
496
496
PV cost of owning
($3,474.2)
Cost of leasing
($2,100)
($2,100)
($2,100)
Lease pmt tax savings
840
840
840
Net cash flow
($1,260
($1,260
($1,260
PV cost of leasing
($3,368.0)