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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 to negotiate a further $30,000, 10 year loan with a financial institution at 14 percent interest thereby financing any purchase entirely through debt. Meanwhile midland leasing ltd. has also offered to make the equipment available under a 10-year financial lease. Lease payments of $11,200 are to the paid at the end of each year. How should the asset be acquired?
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Expert Solution
Since -ve NPV project at Cost of Capital of 15%, it is better to go for leasing.
| 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | |
| Interest on Loan-Supplier | $ 5,400.00 | $ 5,092.29 | $ 4,747.65 | $ 4,361.65 | $ 3,929.33 | $ 3,445.14 | $ 2,902.84 | $ 2,295.46 | $ 1,615.21 | $ 853.32 | |
| Interest on Loan- Institution | $ 4,200.00 | $ 3,982.80 | $ 3,735.20 | $ 3,452.93 | $ 3,131.14 | $ 2,764.31 | $ 2,346.11 | $ 1,869.37 | $ 1,325.89 | $ 706.31 | |
| CCA | $ 7,500.00 | $ 13,500.00 | $ 10,800.00 | $ 8,640.00 | $ 6,912.00 | $ 5,529.60 | $ 4,423.68 | $ 3,538.94 | $ 2,831.16 | $ 2,264.92 | |
| Total expenses for buying machine | $ 17,100.00 | $ 22,575.09 | $ 19,282.84 | $ 16,454.58 | $ 13,972.47 | $ 11,739.04 | $ 9,672.63 | $ 7,703.78 | $ 5,772.25 | $ 3,824.55 | |
| Expenses in case of leasing | $ 11,200.00 | $ 11,200.00 | $ 11,200.00 | $ 11,200.00 | $ 11,200.00 | $ 11,200.00 | $ 11,200.00 | $ 11,200.00 | $ 11,200.00 | $ 11,200.00 | |
| Incremental profit over leasing | $ -5,900.00 | $ -11,375.09 | $ -8,082.84 | $ -5,254.58 | $ -2,772.47 | $ -539.04 | $ 1,527.37 | $ 3,496.22 | $ 5,427.75 | $ 7,375.45 | |
| Tax | $ -2,360.00 | $ -4,550.04 | $ -3,233.14 | $ -2,101.83 | $ -1,108.99 | $ -215.62 | $ 610.95 | $ 1,398.49 | $ 2,171.10 | $ 2,950.18 | |
| PAT | $ -3,540.00 | $ -6,825.05 | $ -4,849.71 | $ -3,152.75 | $ -1,663.48 | $ -323.43 | $ 916.42 | $ 2,097.73 | $ 3,256.65 | $ 4,425.27 | |
| Principle on Loan-Supplier | $ -2,564.29 | $ -2,872.00 | $ -3,216.64 | $ -3,602.64 | $ -4,034.96 | $ -4,519.15 | $ -5,061.45 | $ -5,668.82 | $ -6,349.08 | $ -7,110.97 | |
| Principle on Loan- Institution | $ -1,551.41 | $ -1,768.60 | $ -2,016.21 | $ -2,298.48 | $ -2,620.26 | $ -2,987.10 | $ -3,405.29 | $ -3,882.04 | $ -4,425.52 | $ -5,045.09 | |
| CCA | $ 7,500.00 | $ 13,500.00 | $ 10,800.00 | $ 8,640.00 | $ 6,912.00 | $ 5,529.60 | $ 4,423.68 | $ 3,538.94 | $ 2,831.16 | $ 2,264.92 | |
| Net Cash flow | $ -155.69 | $ 2,034.34 | $ 717.44 | $ -413.86 | $ -1,406.70 | $ -2,300.08 | $ -3,126.64 | $ -3,914.18 | $ -4,686.79 | $ -5,465.87 | |
| NPV @ Cost of capital at 15% | $ -5,194.13 | ||||||||||
| IRR | 50.27% | ||||||||||
| Given | |||||||||||
| Tax rate | 40% | ||||||||||
| CCA | 20% | ||||||||||
| Book value of machine for CCA | $ 75,000.00 | $ 67,500.00 | $ 54,000.00 | $ 43,200.00 | $ 34,560.00 | $ 27,648.00 | $ 22,118.40 | $ 17,694.72 | $ 14,155.78 | $ 11,324.62 | $ 9,059.70 |
| Machine cost | $ -75,000.00 | ||||||||||
| Loan-Supplier | |||||||||||
| Loan amount | $ 45,000.00 | ||||||||||
| Interest rate | 12% | ||||||||||
| Per year repayment | $ 7,964.29 | ||||||||||
| Principle at each year | $ 45,000.00 | $ 42,435.71 | $ 39,563.71 | $ 36,347.07 | $ 32,744.43 | $ 28,709.47 | $ 24,190.32 | $ 19,128.87 | $ 13,460.05 | $ 7,110.97 | $ 0.00 |
| Interest | $ 5,400.00 | $ 5,092.29 | $ 4,747.65 | $ 4,361.65 | $ 3,929.33 | $ 3,445.14 | $ 2,902.84 | $ 2,295.46 | $ 1,615.21 | $ 853.32 | |
| Loan- Institution | |||||||||||
| Loan amount | $ 30,000.00 |
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to be repaid in equal instalments over 10 years. Lavish Carpet pays
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