Question

7.  7: Hybrid Financing: Preferred Stock, Leasing, Warrants, and Convertibles: Equipment Cost Owning

Findley Furniture Company must install $7.2 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 $180,000 per year, payable at the end of the year.

3) Findley’s federal-plus-state tax rate is 40%.

4) If the money is borrowed, the bank loan will be at a rate of 8%, 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 $1.25 million per year for 5 years.

6) At the end of the lease term, the equipment will have an estimated salvage value of $900,000. 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? Do not round intermediate calculations. Enter your answer as a positive value. Enter your answer in thousands. For example, an answer of $10,550,000 should be entered as 10,550. Round your answer to the nearest whole number.

Answer 1

				( in $)
			Options
Sr No	Description	Calculation	Purchase	Lease
1	Value of Equipment		72,00,000	6250000
2	Maintenance		9,00,000
3	EMI Value	18,03,286	90,16,432
4	interest against loan	(3-1)	18,16,432
5	Slaveg Value		9,00,000
6	Tax Savings on Depriciation		28,80,000
7	Net cash outflow	(1+2+4-5-6)	61,36,432	62,50,000
8	Net cash outflow	(In '1000)	6,136	6,250

Option purchase of equipment is better option