Question

In: Finance

You work as financial analyst at Herman Miller Furniture company. You are evaluating g a potential...

You work as financial analyst at Herman Miller Furniture company. You are evaluating g a potential lease agreement on a new machine. The new machine can be purchased on January 1 for $10,000 and can be depreciated over 5-year period using straight line method. The machine has an 8-year actual life and the salvage value at the end of the 8 years is $0. The operating expenses of the machine will be $500 per year. The lease calls for 8 annual payments of $2,000 per year with the first payment occurring immediately. (assume the lease payments will occur at the beginning of each year and the tax benefits associated with the lease payment occurs at the end of the year) the interest rate on the company’s debt is 10%. The weighted average cost of capital of the firm is 15%. The corporate tax rate is 30%.

What is the cost of owning?

What is the cost of leasing?

What is Net Advantage to Leasing/

What is the minimum salvage value for you to be indifferent between lease and buying?

Solutions

Expert Solution

Assumption for answer ,

1. new machine will be purchased all by debt fund

2. principle of debt paid at end of 8th year , only interest have been paid during years

Cost of owning the machine is calculated in Present value term with discounting factor of weighted average cost of capital (15%)

8-year Depreciation Schedule
Year 1 2 3 4 5 6 7 8
Depr. Rate 12.5% 12.5% 12.5% 12.5% 12.5% 12.5% 12.5% 12.5%
Lessee's Depr. Exp. $1,250 $1,250 $1,250 $1,250 $1,250 $1,250 $1,250 $1,250
EOY Book Value $8,750 $7,500 $6,250 $5,000 $3,750 $2,500 $1,250 $0
Lessor's Depr. Exp. $1,250 $1,250 $1,250 $1,250 $1,250 $1,250 $1,250 $1,250
EOY Book Value $8,750 $7,500 $6,250 $5,000 $3,750 $2,500 $1,250 $0
Year = 0 1 2 3 4 5 6 7 8
   Cost of Owning
Equipment cost ($10,000)
Loan amount $10,000
Interest on loan ($1,000) ($1,000) ($1,000) ($1,000) ($1,000) ($1,000) ($1,000) ($1,000)
Tax savings on int. $300 $300 $300 $300 $300 $300 $300 $300
Repayment of loan ($10,000)
Maintenance Cost ($500) ($500) ($500) ($500) ($500) ($500) ($500) ($500) ($500)
Tax savings on main. $150 $150 $150 $150 $150 $150 $150 $150 $150
Tax savings on depr. $375 $375 $375 $375 $375 $375 $375 $375
Residual value $0 $0 $0 $0
Tax on res. value
Net cash flow ($350) ($675) ($675) ($675) ($675) ($675) ($675) ($675) ($10,675)
PV owning ($395.00)
   Cost of Leasing
Lease payment ($2,000) ($2,000) ($2,000) ($2,000) ($2,000) ($2,000) ($2,000) ($2,000) ($2,000)
Tax savings on lease $600 $600 $600 $600 $600 $600 $600 $600 $600
Net cash flow ($1,400) ($1,400) ($1,400) ($1,400) ($1,400) ($1,400) ($1,400) ($1,400) ($1,400)
PV leasing ($1,493.33)
Net Advantage to Leasing = NAL = PV Owning cost   -   PV Leasing cost      =
($1,098.33)

TO in different the lease and buying the salvage value should be greater than 3358


Related Solutions

You work as financial analyst at Herman Miller Furniture company. You are evaluating g a potential...
You work as financial analyst at Herman Miller Furniture company. You are evaluating g a potential lease agreement on a new machine. The new machine can be purchased on January 1 for $10,000 and can be depreciated over 5-year period using straight line method. The machine has an 8-year actual life and the salvage value at the end of the 8 years is $0. The operating expenses of the machine will be $500 per year. The lease calls for 8...
You work as a financial analyst and you will identify a potential investment. You will then...
You work as a financial analyst and you will identify a potential investment. You will then use NPV, PP, PI, and IRR investment criteria to evaluate the opportunity. Finally, you will make a recommendation to the board of the directors of the company. If you make any assumption in your analysis, please specify and explain it. You can Google “business for sale” to find the investment opportunities or find them in a local newspaper’s classified section. You evaluation report will...
As a financial analyst, you are considering a potential investment in a company that appears to...
As a financial analyst, you are considering a potential investment in a company that appears to be of great value.                                                                    Required: a. The company is expected to earn $28 per share at the end of this year. If the fair rate of return for this stock is 10 percent, what is an appropriate price per share for the stock if the company pays out all earnings as dividends? b. If the company were to pay out half of its earnings...
You work as a financial analyst at WPWilly, Inc. You are evaluating how much Acme Limo...
You work as a financial analyst at WPWilly, Inc. You are evaluating how much Acme Limo should charge a client who will lease a car for 7 years. It will cost Acme $85,000 to buy the car and the car can be depreciated on a five-year MACRS schedule. Acme Limo’s pretax administrative costs including Maintenance, Insurance and Selling Cost are $10,000 per year and they occur at the beginning of each year. The after tax cost of capital is 10%...
You work as a financial analyst at WPWilly, Inc. You are evaluating how much Acme Limo...
You work as a financial analyst at WPWilly, Inc. You are evaluating how much Acme Limo should charge a client who will lease a car for 7 years. It will cost Acme $85,000 to buy the car and the car can be depreciated on a five-year MACRS schedule. Acme Limo’s pretax administrative costs including Maintenance, Insurance and Selling Cost are $10,000 per year and they occur at the beginning of each year. The after tax cost of capital is 10%...
You work as a financial analyst at WPWilly, Inc. You are evaluating how much Acme Limo...
You work as a financial analyst at WPWilly, Inc. You are evaluating how much Acme Limo should charge a client who will lease a car for 7 years. It will cost Acme $85,000 to buy the car and the car can be depreciated on a five-year MACRS schedule. Acme Limo’s pretax administrative costs including Maintenance, Insurance and Selling Cost are $10,000 per year and they occur at the beginning of each year. The after tax cost of capital is 10%...
URGENT ANSWER NEEDED: You work as a financial analyst at WPWilly, Inc. You are evaluating how...
URGENT ANSWER NEEDED: You work as a financial analyst at WPWilly, Inc. You are evaluating how much Acme Limo should charge a client who will lease a car for 7 years. It will cost Acme $85,000 to buy the car and the car can be depreciated on a five-year MACRS schedule. Acme Limo’s pretax administrative costs including Maintenance, Insurance and Selling Cost are $10,000 per year and they occur at the beginning of each year. The after tax cost of...
You work for a leveraged buyout firm and are evaluating a potential buyout of UnderWater Company.​...
You work for a leveraged buyout firm and are evaluating a potential buyout of UnderWater Company.​ UnderWater's stock price is $ 23 and it has 2.25 million shares outstanding. You believe that if you buy the company and replace its​ management, its value will increase by 38 %. You are planning on doing a leveraged buyout of UnderWater and will offer $ 28.75 per share for control of the company. a. Assuming you get​ 50% control, what will happen to...
You work for a leveraged buyout firm and are evaluating a potential buyout of UnderWater Company.​...
You work for a leveraged buyout firm and are evaluating a potential buyout of UnderWater Company.​ UnderWater's stock price is $ 23 and it has 2.75 million shares outstanding. You believe that if you buy the company and replace its​ management, its value will increase by 42 %. You are planning on doing a leveraged buyout of UnderWater and will offer $ 28.75 per share for control of the company. a. Assuming you get​ 50% control, what will happen to...
You work for a leveraged buyout firm and are evaluating a potential buyout of UnderWater Company.​...
You work for a leveraged buyout firm and are evaluating a potential buyout of UnderWater Company.​ UnderWater's stock price is $ 15 and it has 1.25 million shares outstanding.You believe that if you buy the company and replace its​ management, its value will increase by 43 %. You are planning on doing a leveraged buyout of UnderWater and will offer $ 18.75 per share for control of the company. a. Assuming you get 50 % ​control, what will happen to...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT