Question

In: Finance

The Randolph Limited has decided to acquire a new truck. One alternative is to lease the...

The Randolph Limited has decided to acquire a new truck. One alternative is to lease the truck on a 4-year guideline contract for a lease payment of R10,000 per year, with payments to be made at the beginning of each year. The lease would include maintenance. Alternatively, Randolph Limited could purchase the truck outright for R40,000, financing the purchase by a bank loan for the net purchase price and amortizing the loan over a 4-year period at an interest rate of 10% per year. Under the borrow-to-purchase arrangement, RTC would have to maintain the truck at a cost of R1,000 per year, payable at year end. The truck falls into the MACRS 3-year class. It has a residual value of R10,000, which is the expected market value after 4 years, when Randolph Ltd plans to replace the truck irrespective of whether it leases or buys. Randolph Limited has a marginal tax rate of 40%.

Required

1.1 What is Randolph’s Present Value cost of leasing?

1.2 What is Randolph’s Present Value cost of owning? Should the truck be leased or purchased?

Solutions

Expert Solution

1.1]

PV of leasing = present value of after-tax lease payments

After tax lease payment = lease payment * (1 - tax rate) = $10,000 * (1 - 40%) = $6,000

For calculating present value, discount rate used is 10%, which is the interest rate on loan

PV of leasing = ($6,000 / (1 + 10%)0) + ($6,000 / (1 + 10%)1) + ($6,000 / (1 + 10%)2​​​​​​​) + ($6,000 / (1 + 10%)3​​​​​​​)

PV of leasing = $20,921

1.2]

PV of owning = PV of each year's cash flow

Each year's cash flow = loan payments - interest tax shield - depreciation tax shield + maintenance costs

In year 4, after-tax residual value is added to that year's cash flow

The loan principal is assumed to be repaid in 4 years, with 25% principal in each year. Interest in each year = principal outstanding * interest rate

depreciation tax shield = depreciation amount * tax rate

interest tax shield = interest amount * tax rate

after-tax residual value = residual value * (1 - tax rate) = $10,000 * (1 - 40%) = $6,000

Discount factor for each year = 1 / (1 + 10%)year

Present value of cash flows = $30,632

PV of owning is $30,632

Leasing is recommended as the PV of leasing is lower


Related Solutions

Sirius has decided to acquire a new equipment at a cost of $748,000. The equipment has...
Sirius has decided to acquire a new equipment at a cost of $748,000. The equipment has an expected life of 6 years and will be depreciated using 5-year MACRS with rates of .20, .32, .192, .1152, .1152, and .0576 (note that 5-year MACRS depreciation actually takes place over 6 years). There is no actual salvage value. Travis Capital has offered to lease the equipment to Sirius for $153,000 a year for 6 years, with lease payment at the end of...
The lavish carpet manufacturing co. has decided to acquire a new machine that has an economic...
The lavish carpet manufacturing co. has decided to acquire a new machine that has an economic life of 10 years, with no residual value. The machine can be purchased for $75,000 and the supplier is willing to advance $45,000 of the purchase price at 12 percent. The loan is to be repaid in equal instalments over 10 years. Lavish Carpet pays 40 percent corporate income tax and can claim 20 percent capital cost allowances on the purchased asset. It expects...
1) The lavish carpet manufacturing co. has decided to acquire a new machine that has an...
1) The lavish carpet manufacturing co. has decided to acquire a new machine that has an economic life of 10 years, with no residual value. The machine can be purchased for $75,000 and the supplier is willing to advance $45,000 of the purchase price at 12 percent. The loan is to be repaid in equal instalments over 10 years. Lavish Carpet pays 40 percent corporate income tax and can claim 20 percent capital cost allowances on the purchased asset. It...
Mattel, Inc. has decided to acquire a new equipment at a cost of $760,000. The equipment...
Mattel, Inc. has decided to acquire a new equipment at a cost of $760,000. The equipment has an expected life of 6 years and will be depreciated using 5-year MACRS with rates of .20, .32, .192, .1152, .1152, and .0576 (note that 5-year MACRS depreciation actually takes place over 6 years). There is no actual salvage value. Mass Financing has offered to lease the equipment to Mattel for $148,000 a year for 6 years. Mattel has a cost of equity...
Mattel, Inc. has decided to acquire a new equipment at a cost of $760,000. The equipment...
Mattel, Inc. has decided to acquire a new equipment at a cost of $760,000. The equipment has an expected life of 6 years and will be depreciated using 5-year MACRS with rates of .20, .32, .192, .1152, .1152, and .0576 (note that 5-year MACRS depreciation actually takes place over 6 years). There is no actual salvage value. Mass Financing has offered to lease the equipment to Mattel for $148,000 a year for 6 years. Mattel has a cost of equity...
The Lavish Carpet Manufacturing Co. has decided acquire a new machine that has an economic life...
The Lavish Carpet Manufacturing Co. has decided acquire a new machine that has an economic life of 10 years, with no residual value. The machine can be purchased for $75,000, and the supplier is willing to advance $45,000 of the purchase price at 12 percent. The loan is to be repaid in equal instalments over 10 years. Lavish Carpet pays 40 percent corporate income tax and can claim 20 percent capital cost allowances on the purchased asset. It expects to...
Duhok Inc. has decided to acquire a new machine that can either be purchased for $4,200,000...
Duhok Inc. has decided to acquire a new machine that can either be purchased for $4,200,000 and depreciated at a 30% CCA rate or leased for a 5-year period for $800,000 per year (due at the beginning of each year). The firm can borrow at 8%, has a 40% marginal tax rate, and 12% WACC. The new machine has an expected useful life of 5 years and an expected salvage value of $1,000,000 at the end of the fifth year....
The Del Castillo Company (DCC) has decided to acquire a computer for one of its hotel....
The Del Castillo Company (DCC) has decided to acquire a computer for one of its hotel. The computer can be leased on a 5-year contract for $10,000 per year. Payments would be made at the beginning of each year. Alternatively, DCC could purchase the computer for $30,000 by financing the enitre cost of the computer with a loan to be amortized over a 4-year period. The annual interest rate would be 12% and payments would be due at the end...
Sanders Limited is considering whether to lease its equipment as an alternative to borrowing to purchase...
Sanders Limited is considering whether to lease its equipment as an alternative to borrowing to purchase it. The equipment will cost $230,000. This amount can be borrowed from a local bank at 8.5% interest with annual payments amortized over 6 years. Payments would be at the end of the year. The CCA rate on this equipment would be 25%, and the expected salvage at the end of 6 years is $33,000. Alternatively, lease payments of $47,000 could be made each...
Veritas Inc. has decided to acquire a new Hydraulic Excavator. It has three options. Caterpillar: purchase...
Veritas Inc. has decided to acquire a new Hydraulic Excavator. It has three options. Caterpillar: purchase cost of $350,324 and operating costs of $21,964 per year (paid at the end of each year). John Deere: purchase cost of $285,068 and operating costs of $20,274 per year (paid at the end of each year). Volvo: purchase cost of $307,686 and operating costs of $15,767 per year (paid at the end of each year). Assume that Geek Inc. has a budget of...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT