To finance some manufacturing tools it needs for the next 4 years, Waldrop Corpo
ID: 2718450 • 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 $1.59 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 cash outflow under Leasing alternative:
Year Lease rent after taxes PVIFA @9% (140%) Total PV
[($400,000(140%)]
1-4 $240,000 3.2397 $777,528
Schedule of depreciation:
Years Asset value Depreciation factor Depreciation
1 $1,590,000 0.3333 $529,947
2 $1,590,000 0.4445 $706,755
3 $1,590,000 0.1481 $235,479
4 $1,590,000 0.0741 $117,819
Under MACRS method, scrap value is not considered
Schedule of debt payment (Simple Interest):
Year Interest on 1.59 million Principal Total
1 $238,500 $238,500
2 $238,500 $238,500
3 $238,500 $238,500
4 $238,500 $1,590,000 $1,828,500
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Total $2,544,000
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Tax advantages on interest in buying option:
Year interest tax advantage on interest net interest
1 238,500 $95,400 $143,100
2 238,500 $95,400 $143,100
3 238,500 $95,400 $143,100
4 238,500 $95,400 $143,100
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Total $381,600 $572,400
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Tax advantages on depreciation in buying option:
Year Depreciation tax advantage on Depreciation Net Depreciation
1 $529,947 211,979 $317,968
2 $706,755 282,702 $424,053
3 $235,479 94,191 $141,288
4 $117,819 47,128 $70,691
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Total 636,000 $954,000
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Calculation of present value of cash outflows under buying option:
Year Cash out flow interest factor @9% Total PV
1-4 143,100 3.2397 $463,601
4th year 1,590,000 0.7084 $1,126,356
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We have to consider the Deprecation tax advantage also in the present value process.
Time is not sufficient to complete the problem