Question

Quantitative Problem 1: Findley Furniture Company must install $7.0 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 20%, 32%, 19%, 12%, 11%, and 6%.
2. The lease includes maintenance, whereas if the equipment is purchased, it would require maintenance provided by a service contract for $170,000 per year, payable at the end of the year.
3. Findley’s federal-plus-state tax rate is 45%.
4. If the money is borrowed, the bank loan will be at a rate of 11%, 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 $1.35 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 firm’s cost of owning the equipment? Enter your answer in thousands. For example, an answer of $1,234,000 should be entered as 1,234. Do not round intermediate calculations. Round your answer to the nearest thousand dollars. Enter your answer as a positive number.
$   thousand

Answer 1

NPV OF BUYING:
Annual installments of the loan = 7000*0.11*1.11^5/(1.11^5-1) =	$            1,894
Interest rate for discounting = 11%*(1-45%) =	6.05%
	0	1	2	3	4	5
Beginning balance of loan		$              7,000	$             5,876	$           4,628	$              3,243	$            1,706
Interest at 11%		$                  770	$                 646	$              509	$                  357	$                188
Total		$              7,770	$             6,522	$           5,137	$              3,600	$            1,894
Installment		$              1,894	$             1,894	$           1,894	$              1,894	$            1,894
Ending balance		$              5,876	$             4,628	$           3,243	$              1,706	$                   -0
Depreciation under MACRS		$              1,400	$             2,240	$           1,330	$                  840	$                770	420
Cash flows of buying:
Principal repayment		$            -1,124	$            -1,248	$         -1,385	$             -1,537	$           -1,706	-7000
After tax interest [Interest * (1-45%)]		$                -424	$               -355	$             -280	$                -196	$              -103
After tax maintenance cost		$                  -96	$                  -96	$               -96	$                   -96	$                 -96
After tax salvage value [800-(800-420)*45%]						$                629
Tax shield on depreciation		$                  630	$             1,008	$              599	$                  378	$                347
After tax cash flows from buying		$            -1,014	$               -691	$         -1,163	$             -1,452	$              -930
PVIF at 6.05% [PVIF = 1/1.0605^t]		0.94295	0.88540	0.83136	0.78062	0.73298
PV at 9.24%		$                -956	$               -612	$             -967	$             -1,133	$              -682	-4350
NPV of buying	$           -4,350