Question

1. Maersk is negotiating to lease ten new cargo containers with GE Leasing. The firm has received an offer from BSL Containers for a total purchase price of $1,000,000. The terms of the lease include four payments of $270,000, with each payment occurring at the beginning of the year. An alternative to leasing is to borrow the money and buy the containers. The $1,000,000 amortized term loan for four years has an annual interest rate of 10%. Assume the trucks fall into the MACRS 3-year class and has an expected residual value of $100,000. The applicable depreciation rates are .3333, .4445, .1481 and .0741. Maintenance costs would be included in the lease. If the containers are purchased, a maintenance contract would be bought at the beginning of each year for $15,000 annually. Maersk plans to buy a new fleet of containers at the end of the fourth year. The firm has an effective tax rate of 21%.

a). What is Ace’s present value of the cost of owning?

b.) What is Ace’s present value of the cost of leasing?

c.) What is Ace’s Net Advantage to Leasing (NAL)?

Answer 1

a)	PV COST OF OWNING:
	Discount rate = 10*(1-0.21) =	7.90%
	Loan amortization:
	Annual installments due at the end of the year = 1000000*0.10*1.1^4/(1.1^4-1) =	$   3,15,471
	Amortization table:
		0	1	2	3	4
	Beginning loan balance		1000000	784529	547511	286791
	Interest at 10%		100000	78453	54751	28679
	Total		1100000	862982	602262	315470
	Less: Installment payment		315471	315471	315471	315470
	Ending loan balance		784529	547511	286791	0
	After tax interest (Interest*0.79)		79000	61978	43253	22656
	Repayment of principal		215471	237018	260720	286791
	Depreciation:
	Depreciation rate		0.3333	0.4445	0.1481	0.0741
	Depreciation on 1000000		333300	444500	148100	74100	1000000
	The PV of owning is calculated in the table below:
	Principal repayment		-215471	-237018	-260720	-286791	-1000000
	After tax interest		-79000	-61978	-43253	-22656	-206888
	Tax shield on depreciation at 21%		69993	93345	31101	15561	210000
	After tax maintenance costs (15000*0.79)	-11850	-11850	-11850	-11850
	After tax residual value = 100000*79% =					79000
	Net cash flows	-11850	-236328	-217501	-284722	-214886
	PVIF at 7.9%	1	0.92678	0.85893	0.79604	0.73776
	PV at 7.9%	-11850	-219025	-186818	-226651	-158534
	PV OF OWNING	$ -8,02,878
b)	PV OF LEASING:
	After tax lease payments = 270000*(1-0.21) =	213300
	PV of leasing = -213300*1.079*(1.079^4-1)/(0.079*1.079^4) =	$ -7,63,988
c)	NET ADVANTAGE OF LEASING:
	PV of leasing	$ -7,63,988
	Less: PV of owning	$ -8,02,878
	NET ADVANTAGE OF LEASING:	$38,890