Problem 19-4 Lease versus Buy Big Sky Mining Company must install $1.5 million o
ID: 2730592 • 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:
The machinery falls into the MACRS 3-year class.
Under either the lease or the purchase, Big Sky must pay for insurance, property taxes, and maintenance.
The firm's tax rate is 35%.
The loan would have an interest rate of 13%. (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.)
The lease terms call for $400,000 payments at the end of each of the next 4 years.
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.
What is the NAL of the lease? Round your answer to the nearest dollar.
$
MACRS Year Allowance Factor 1 0.3333 2 0.4445 3 0.1481 4 0.0741Explanation / Answer
Answer (19-4)
Buy Option
Purchase Price of Machinery = $1500000
Since interest payment are made at the end of each of year and the whole amount of loan will be paid at the end of 4th year ,
Anuual Interest Payment = $1500000 * 13% =$195000
lease option
Calcualtion of Net Advantage of lease option (NAL )
Note : Calculation of Depreciation under MACRS
Year Interest payment(A) Depreciation(B) C=A+B Tax Shield on C @ 35%(D) Cash out Flow(C-D) PVF @ 8% Total Present Value 1 $195,000 $499,950 $694,950 $243,232.50 $451,717.50 0.925926 $418,256.98 2 $195,000 $666,750 $861,750 $301,612.50 $560,137.50 0.857339 $480,227.72 3 $195,000 $222,150 $417,150 $146,002.50 $271,147.50 0.793832 $215,245.56 4 $195,000 $111,150 $306,150 $107,152.50 $198,997.50 0.735029 $146,268.93 Total present Value of outflow $1,259,999.20 Less: Present Value of Salvage value ( $300000 * 0.735029) ($220,508.70) Net Present Value of Cash Outflow $1,039,490.50