Delamont Transport Company (DTC) is evaluating the merits of leasing versus purc
ID: 2701885 • Letter: D
Question
Delamont Transport Company (DTC) is evaluating the merits of leasing versus purchasing a truck with a 4-year life that costs $40,000 and falls into the MACRS 3-year class. If the firm borrows and buys the truck, the loan rate would be 10%, and the loan would be amortized over the truck's 4-year life, so the interest expense for taxes would decline over time. The loan payments would be made at the end of each year. The truck will be used for 4 years, at the end of which time it will be sold at an estimated residual value of $10,000. If DTC buys the truck, it would purchase a maintenance contract that costs $1,000 per year, payable at the end of each year. The lease terms, which include maintenance, call for a $10,000 lease payment (4 payments total) at the beginning of each year. DTC's tax rate is 40%. What is the net advantage to leasing? (Note: Assume MACRS rates for Years 1 to 4 are 0.3333, 0.4445, 0.15, and 0.07.)
Please include all work
Explanation / Answer
3.16987 is the factor from the table for the present value of an ordinary annuity 10%, 4 periods. 40,000/3.16987 = 12,618.81 is the amount of the payment
Beg. Loan principal
Payment
Interest
MACRS rate
Depreciation
Pre-tax cost*
After tax cost**
40,000
12,618.81
4,000
33.33
13,332
13618.81
6286.01
31,381.19
12,618.81
3,138.12
44.45
17,780
13618.81
4851.56
21,900.50
12,618.81
2,190.05
14.81
5924
13618.81
9973.19
11,471.74
12,618.81
1,147.17
7.41
2964
13618.81
11,574.32
32685.08
*pre tax is the payment of 12,618.81 for the loan plus the 1000 maintnance contract.
**after tax is pre tax minus 40% of (the maintenance contract plus interest paid plus depreciation)
At the end, the truck will be sold for a gain of 10,000. After tax the gain is 6,000.
Cost of truck over the 4 years: 32,685.08 %u2013 6000 = 26,685.08
After tax cost of leasing each year is 10,000 (1 %u2013 0.40) = 6,000.
This is a total of 24,000 for all four years.
Answer: the Firm should lease. The net advantage is a total of 2685.08 for all four years (26685.08 %u2013 24000).
Beg. Loan principal
Payment
Interest
MACRS rate
Depreciation
Pre-tax cost*
After tax cost**
40,000
12,618.81
4,000
33.33
13,332
13618.81
6286.01
31,381.19
12,618.81
3,138.12
44.45
17,780
13618.81
4851.56
21,900.50
12,618.81
2,190.05
14.81
5924
13618.81
9973.19
11,471.74
12,618.81
1,147.17
7.41
2964
13618.81
11,574.32
32685.08