Question

Lewis Health System Inc. has decided to acquire a new electronic health record system for its Richmond hospital. The system receives clinical data and other patient information from nursing units and other patient care areas, then either displays the information on a screen or stores it for later retrieval by physicians. The system also permits patients to call up their health record on Lewis's website. The equipment costs $1,000,000, and, if it were purchased, Lewis could obtain a term loan for the full purchase price at a 10 percent interest rate. Although the equipment has a six-year useful life, it is classified as a special-purpose computer, so it falls into the MACRS three-year class. If the system were purchased, a four-year maintenance contract could be obtained at a cost of $20,000 per year, payable at the beginning of each year. The equipment would be sold after four years, and the best estimate of its residual value at that time is $200,000. However, since real-time display system technology is changing rapidly, the actual residual value is uncertain. As an alternative to the borrow-and-buy plan, the equipment manufacturer informed Lewis that Consolidated Leasing would be willing to write a four-year guideline lease on the equipment, including maintenance, for payments of $260,000 at the beginning of each year. Lewis's marginal federal-plus-state tax rate is 40 percent. You have been asked to analyze the lease-versus-purchase decision, and in the process to answer the following questions: a. What is the present value cost of owning the equipment? b. What is the present value cost of leasing the equipment? c. What is the net advantage to leasing (NAL)? d. Answer these questions one at a time to see the effect of the change on NAL. That is, starting with the original numbers you used for questions a. and b., what is the NAL if: - interest rate increases to 12 percent - the tax rate falls to 34 percent - maintenance cost increases to $25,000 per year - residual value falls to $150,000 - the system price increases to $1,050,000 e. Do the changes in d. make leasing more or less attractive? Explain.

I need to use structure for the answers:

			Year 0	Year 1	Year 2	Year 3	Year 4
Cost of owning:
Net purchase price
Maintenance cost
Maintenance tax savings
Depreciation tax savings
Residual value
Tax on residual value
Net cash flow
Cost of leasing:
Lease payment
Lease tax savings
Maintenance cost
Maintenance tax savings
Net cash flow
Net advantage to leasing:
PV cost of leasing
PV cost of owning
NAL

Answer 1

		Year	1	2	3	4
	X	MACRS 3 year Depreciation Rate	33.33%	44.45%	14.81%	7.41%
	Y=X*1000000	Depreciation amount	$        333,300	$        444,500	$        148,100	$        74,100
	Z=Y*0.4	Depreciation tax saving	$        133,320	$        177,800	$          59,240	$        29,640
	N	Year		0	1	2	3	4
		Cost of owning:
	A	Net purchase price		($1,000,000)
	B	Maintenance cost		($20,000)	($20,000)	($20,000)	($20,000)
	C=B*0.4	Maintenance tax savings			$8,000	$8,000	$8,000	$8,000
	D(calculation given above)	Depreciation tax savings			$     133,320	$   177,800	$       59,240	$   29,640
	E	Residual value						$200,000
	F=E*0.4	Tax on residual value						($80,000)
	G=A+B+C+D+E+F	Net cash flow		($1,020,000)	$121,320	$165,800	$47,240	$157,640
		Cost of leasing:
	H	Lease payment		($260,000)	($260,000)	($260,000)	($260,000)
	I=H*0.4	Lease tax savings			$     104,000	$   104,000	$     104,000	$ 104,000
	J	Maintenance cost			$0	$0	$0	$0
	K	Maintenance tax savings			$0	$0	$0	$0
	L=H+I+J+K	Net cash flow		($260,000)	($156,000)	($156,000)	($156,000)	$104,000
	M=L-G	Net advantage to leasing:		$760,000	($277,320)	($321,800)	($203,240)	($53,640)	SUM
	PVL=L/(1.1^N)	PV cost of leasing	$     (576,916)	-260000	-141818.1818	-128925.62	-117205.1089	71033.399	-576915.511
	PVO=G/(1.1^N)	PV cost of owning	$     (629,522)	-1020000	110290.9091	137024.793	35492.11119	107670.24	-629521.945
	NAL=(629522-576916)	NAL(Net advantage to Leasing)	$       52,606
	b	If interest rate=12%, Tax rate=34%
		Maintenance cost=$25000 per year
		Residual value=$150000
		System Price =$1050000
	N	Year		0	1	2	3	4
		Cost of owning:
	A	Net purchase price		($1,050,000)
	B	Maintenance cost		($25,000)	($25,000)	($25,000)	($25,000)
	C=B*0.34	Maintenance tax savings			$8,500	$8,500	$8,500	$8,500
	D=(Calculation given below)	Depreciation tax savings			$     118,988	$   158,687	$       52,872	$   26,454
	E	Residual value						$150,000
	F=E*0.34	Tax on residual value						($51,000)
	G=A+B+C+D+E+F	Net cash flow		($1,075,000)	$102,488	$142,187	$36,372	$133,954
		Cost of leasing:
	H	Lease payment		($260,000)	($260,000)	($260,000)	($260,000)
	I=H*0.34	Lease tax savings			$       88,400	$     88,400	$       88,400	$   88,400
	J	Maintenance cost			$0	$0	$0	$0
	K	Maintenance tax savings			$0	$0	$0	$0
	L=H+I+J+K	Net cash flow		($260,000)	($171,600)	($171,600)	($171,600)	$88,400
	M=L-G	Net advantage to leasing:		$815,000	($274,088)	($313,787)	($207,972)	($45,554)	SUM
	PVL=L/(1.12^N)	PV cost of leasing	$     (611,776)	-260000	-153214.2857	-136798.469	-122141.4905	60378.389	-611775.856
	PVO=G/(1.12^N)	PV cost of owning	$     (759,124)	-1075000	91507.23214	113350.207	25888.65764	85129.998	-759123.905
	NAL=(759124-611776)	NAL(Net advantage to Leasing)	$      147,348
		Year	1	2	3	4
	X	MACRS 3 year Depreciation Rate	33.33%	44.45%	14.81%	7.41%
	Y=X*1050000	Depreciation amount	$        349,965	$        466,725	$        155,505	$        77,805
	Z=Y*0.34	Depreciation tax saving	$        118,988	$        158,687	$          52,872	$        26,454