Question
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 $56,000 per year. The firm's tax rate is 37%. 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 $220,000, 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 %
_
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:_______
Solutions
Expert Solution
To equate the cash flow present value we need to take discount rate which is 13% in this question.
Net present out flow in buying 945708
Net present out flow in leasing 763345
Net advantage of leasing is $ 182363
As we can see lesaing desision is saving 182363 cash outflow in terms of present value.
hence leasing should be choosed.
further net advantage of leasing is $ 182363.
calucations are given below.
| Buying | |||||||
| year | 0 | 1 | 2 | 3 | 4 | 5 | 6 |
| Cost | -1000000 | ||||||
| Depriciation Tax benefit | 122100 | 164465 | 54797 | 27417 | |||
| Maintainace cost | -56000 | -56000 | -56000 | ||||
| Interest cost after tax effect | -81900 | -72059 | -60940 | -48374 | -34175 | -18131 | |
| Net cash flow | -1000000 | -15800 | 36405.54971 | -62142.62913 | -20957.23121 | -34175.332 | -18130.575 |
| NPV | ₹ -9,45,708.22 | ||||||
| year | 0 | 1 | 2 | 3 | |||
| Depriciation Rate | 33% | 44% | 15% | 7% | |||
| Amount depriciation | $ 3,30,000 | $ 4,44,500 | $ 1,48,100 | $ 74,100 | |||
| Tax benefit due to deprication @37% | $ 1,22,100 | $ 1,64,465 | $ 54,797 | $ 27,417 | |||
| Interest calculation | $ - | ||||||
| EMI | $ 2,50,153.23 | ||||||
| PMT(13%,6,-1000000) | |||||||
| year | Balance principle | EMI | Principle | Interest | Interest(after tax effect of 37 % | ||
| 1 | $ 10,00,000 | $ 2,50,153 | $ 1,20,153 | $ 1,30,000 | $ 81,900 | ||
| 2 | $ 8,79,847 | $ 2,50,153 | $ 1,35,773 | $ 1,14,380 | $ 72,059 | ||
| 3 | $ 7,44,074 | $ 2,50,153 | $ 1,53,424 | $ 96,730 | $ 60,940 | ||
| 4 | $ 5,90,650 | $ 2,50,153 | $ 1,73,369 | $ 76,784 | $ 48,374 | ||
| 5 | $ 4,17,281 | $ 2,50,153 | $ 1,95,907 | $ 54,247 | $ 34,175 | ||
| 6 | $ 2,21,375 | $ 2,50,153 | $ 2,21,375 | $ 28,779 | $ 18,131 | ||
| Lease | |||||||
| Year | 0 | 1 | 2 | 3 | 4 | 5 | 6 |
| Lease Payment | $ -2,80,000.00 | -280000 | -280000 | ||||
| Payment for machine | -220000 | ||||||
| Depriciation tax benefit | 26862 | 36182.3 | 12055.34 | 6031.74 | |||
| cash flow | $ -2,80,000.00 | $ -2,80,000.00 | $ -4,73,138.00 | $ 36,182.30 | $ 12,055.34 | $ 6,031.74 | |
| NPV | ₹ -7,63,345.46 | $ 1,82,362.76 | |||||
| Value of equipment | $ -2,20,000.00 | ||||||
| Depriciation Calculation | |||||||
| year | 0 | 1 | 2 | 3 | |||
| Depriciation Rate | 33% | 44% | 15% | 7% | |||
| Amount depriciation | $ 72,600 | $ 97,790 | $ 32,582 | $ 16,302 | |||
| Tax benefit due to deprication @37% | $ 26,862 | $ 36,182 | $ 12,055 | $ 6,032 | |||
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Texas plant. It can obtain a 6-year bank loan for 100% of the cost
at a 14% interest rate with equal payments at the end of each year.
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Year
3-year MACRS
1
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2
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4
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Alternatively, a Texas investment banking firm that represents a
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at a 14% interest rate with equal payments at the end of each year.
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class.
Alternatively, a Texas investment banking firm that represents a
group of investors can arrange a guideline lease calling for
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represents a group of investors can arrange a guideline lease
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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
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Sadik Industries must install $1 million of new machinery in its
Texas plant. It can obtain a 6-year bank loan for 100% of the cost
at a 15% interest rate with equal payments at the end of each year.
Sadik’s tax rate is 33%. The equipment falls in the MACRS 3-year
class.
Year
3-year MACRS
1
33.33%
2
44.45%
3
14.81%
4
7.41%
Alternatively, a Texas investment banking firm that represents a
group of investors...
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at a 14% interest rate with equal payments at the end of each year.
Sadik’s tax rate is 34%. The equipment falls in the MACRS 3-year
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