To finance some manufacturing tools it needs for the next 4 years, Waldrop Corpo
ID: 2717655 • 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 $1.58 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
depreciation (MACRS
3-year class)
The net advantage to leasing is $22.4 - $15.63= $6.77
year interest paiddepreciation (MACRS
3-year class)
expense with 40% effect lease per year lease with tax effect 0 ($15.8) ($15.8) 1 2.37 5.26 10.68 4 5.6 2 2.37 4.68 9.87 4 5.6 3 2.37 0.87 4.54 4 5.6 4 2.37 0.37 3.84 4 5.6 salvage value 2.50 0 cost advantage $15.63 $22.40