Problem 19-04 Lease versus Buy Big Sky Mining Company must install $1.5 million
ID: 2792365 • Letter: P
Question
Problem 19-04
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 12%. It would be nonamortizing, with only interest paid at the end of each year for four years and the principal repaid at 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 $250,000 at the end of the 4th year.
What is the NAL of the lease? Round your answer to the nearest dollar.
Problem 19-04
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 12%. It would be nonamortizing, with only interest paid at the end of each year for four years and the principal repaid at 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 $250,000 at the end of the 4th year.
MACRS Year Allowance Factor 1 0.3333 2 0.4445 3 0.1481 4 0.0741What is the NAL of the lease? Round your answer to the nearest dollar.
Explanation / Answer
Cost of asset 1500000 Usful life (Years) 4 Depreciation MACRS Tax rate 35% Interest rate 12% Salvage Value 250000 Lease payments 400000 Cost of Capital = Cost of Debt = 12 x (1-t) = 12 x 0.65 = 7.8% Net advantage of leasing = Cost of buying - cost of leasing 1) Cost of leasing = Amount($) PV of Lease rentals gone = 400000 x PVAF(7.8%,4) 1330770.16 Less : PV of tax shield on lease rentals = (400000 x 35% x PVAF(7.8%,4) 465769.556 Cost of leasing = 865000.604 2) Cost of buying - Year Loan Repayment Interest @ 12% ITS Depreciation allowance factors Depreciation DTS Net out flow PV Factors @ 7.8% Present Value a b c d e f g h i j =1500000 x 12% = C x 0.35 = e x 1500000 = f x 0.35 = b+c-d-g 1 0 180000 63000 0.3333 49995 17498.25 99501.75 0.927643785 92302.17996 2 0 180000 63000 0.4445 66675 23336.25 93663.75 0.860522991 80599.81034 3 0 180000 63000 0.1481 22215 7775.25 109224.75 0.798258805 87189.61838 4 1500000 180000 63000 0.0741 11115 3890.25 1613109.75 0.740499819 1194507.478 1454599.086 Less : PV of salvage value = 250000 x (1-0.35) x PVIF(7.8%,4) = 250000 x 0.65 x 0.7405 = -120331.2206 Cost of buying - 1334267.87 3) Net advantage of Leasing = Cost of buying - 1334267.866 less: Cost of leasing = 865000.6039 469267.2618 As NAL is positive leasing is advisable . Please provide feedback… Thanks in Advance :-)