ABC Company must install $5.9 million of new equipment in one of its plants. It
ID: 2778346 • Letter: A
Question
ABC Company must install $5.9 million of new equipment in one of its plants. It can obtain a bank loan for 100% of the required amount. Alternatively, management believes it can arrange a lease. Assume that the following facts apply:
1. The equipment falls in the MACRS 5-year class. The applicable MACRS rates are 21%, 33%, 20%, 12%, 11%, and 8%.
2. The lease includes maintenance, whereas if the equipment is purchased, it would require maintenance provided by a service contract for $120,000 per year, payable at the end of the year.
3. ABC’s federal-plus-state tax rate is 35%.
4. If the money is borrowed, the bank loan will be at a rate of 8%, amortized in 5 equal installments to be paid at the end of each year.
5. The tentative lease terms call for end-of-year payments of $1.15 million per year for 5 years.
6. At the end of the lease term, the equipment will have an estimated salvage value of $800,000. At that time, Findley plans to replace the equipment regardless of whether the firm leases or purchases it.
What is the net advantage to leasing? Please show the calculation
Explanation / Answer
ABC Company must install $5.9 million of new equipment in one of its plants. It