Problem 19-4 Lease versus Buy Big Sky Mining Company must install $1.5 million o
ID: 2730334 • Letter: P
Question
Problem 19-4 Lease versus Buy Big Sky Mining Company must install $1.5 million of new machinery in its Nevada mine. It can obtain a bank loan for 100% of the purchase price, or it can lease the machinery. Assume that the following facts apply: 1.The machinery falls into the MACRS 3-year class. 2.Under either the lease or the purchase, Big Sky must pay for insurance, property taxes, and maintenance. 3.The firm's tax rate is 35%. 4.The loan would have an interest rate of 16%. (Suppose that only interest payments are made at the end of each year and the whole loan will be paid back at the end of year 4.) 5.The lease terms call for $400,000 payments at the end of each of the next 4 years. 6.Big Sky Mining has no use for the machine beyond the expiration of the lease, and the machine has an estimated residual value of $300,000 at the end of the 4th year. MACRS Year Allowance Factor 1 0.3333 2 0.4445 3 0.1481 4 0.0741 What is the NAL of the lease? Round your answer to the nearest dollar.Explanation / Answer
Answer:
Cost of machine 1,500,000 Tax rate 35.0% Interest rate 16.0% Lease payments 400,000 Residual Value 300,000 After-tax cost of debt 10.4% Year 0 1 2 3 4 Principal Payment (1,500,000) = borrows $1.5M and pays at the end of 4 years Interest Payments (240,000) (240,000) (240,000) (240,000) = $1.5M x 16% Tax shield from interest 84,000 84,000 84,000 84,000 = $225,000 x 35% After-tax loan payments (156,000) (156,000) (156,000) (1,656,000) MACRS 3-year factors 0.3333 0.4445 0.1481 0.0741 = from MACRS table in book Depreciation 499,950 666,750 222,150 111,150 = cost of machine x MACRS factor Tax shield from depreciation 174,983 233,363 77,753 38,903 Cost of Owning 0 1 2 3 4 After-tax loan payments (156,000) (156,000) (156,000) (1,656,000) = from above Tax shield from depreciation 174,983 233,363 77,753 38,903 = from above Residual value 300,000 = given Tax on residual value (105,000) = residual value x tax rate Net cash flow 18,983 77,363 (78,248) (1,422,098) PV Cost of ownership@ 10.4% (934,795) Cost of Leasing 0 1 2 3 4 Lease payments (400,000) (400,000) (400,000) (400,000) = given Tax shield from lease 140,000 140,000 140,000 140,000 = lease payments x tax rate After-tax lease payments (260,000) (260,000) (260,000) (260,000) PV cost of leasing@ 10.4% (817,079) Net Advantage to Leasing 117,716