In: Finance
Sadik Industries must install $1 million of new machinery in its
Texas plant. It can obtain...
Sadik Industries must install $1 million of new machinery in its
Texas plant. It can obtain a bank loan for 100% of the required
amount. Alternatively, a Texas investment banking firm that
represents a group of investors believes that it can arrange for a
lease financing plan. Assume that these facts apply:
- The equipment falls in the MACRS 3-year class.
- Estimated maintenance expenses are $46,000 per year.
- The firm's tax rate is 31%.
- If the money is borrowed, the bank loan will be at a rate of
13%, amortized in six equal installments at the end of each
year.
- The tentative lease terms call for payments of $280,000 at the
end of each year for 3 years. The lease is a guideline lease.
- Under the proposed lease terms, the lessee must pay for
insurance, property taxes, and maintenance.
- Sadik must use the equipment if it is to continue in business,
so it will almost certainly want to acquire the property at the end
of the lease. If it does, then under the lease terms it can
purchase the machinery at its fair market value at Year 3. The best
estimate of this market value is $160,000, but it could be much
higher or lower under certain circumstances. If purchased at Year
3, the used equipment would fall into the MACRS 3-year class. Sadik
would actually be able to make the purchase on the last day of the
year (i.e., slightly before Year 3), so Sadik would get to take the
first depreciation expense at Year 3 (the remaining depreciation
expenses would be at Year 4 through Year 6). On the time line,
Sadik would show the cost of the used equipment at Year 3 and its
depreciation expenses starting at Year 3.
Year |
3-year MACRS |
1 |
33.33 |
% |
2 |
44.45 |
% |
3 |
14.81 |
% |
4 |
7.41 |
% |
The data has been collected in the Microsoft Excel Online file
below. Open the spreadsheet and perform the required analysis to
answer the questions below.
Open spreadsheet
To assist management in making the proper lease-versus-buy
decision, you are asked to answer the following questions:
-
What is the net advantage of leasing? Should Sadik take the
lease? Do not round intermediate calculations. Round your answer to
the nearest dollar.
Net advantage of leasing $
Since the cost of leasing the machinery is _________lessgreater
than the cost of owning it, the firm should _______leasebuy the
equipment.
-
The decision almost can be considered a bet on the future
residual value. Do you think the residual cash flows are equal in
risk to the other cash flows? (Hint: if you discount a
negative cash flow at a higher rate, you get a better NPV — the NPV
of a negative cash flow stream is less negative at high discount
rates.)
_____Yes.No.