Question

You have the option to purchase or lease a five-axis horizontal machining center. Any revenues generated from the operation of the machine will be the same whether it is leased or purchased. Considering the information given, should you lease or purchase the machine? Conduct after-tax analyses of both options. The effective income tax rate is 38%, the evaluation period is five years, and the MARR is 9% per year.

Notes: (1) Under the Lease Option, maintenance costs are included in the annual leasing cost. (2) Leasing costs are paid at the beginning of each year and are tax deductible. (3) Depreciation deuctions cannot be taken or leased equipment. (4) Depositis are not tax decutbile and refunds of deposits are not taxable; however, owing to the difference in timing between payment and refund, they must be considered in your analysis.

Leasing Option

Annual Leasing cost: $57,000

Deposit (paid at EOY zero, refunded at EOY five): $82,000

Purchasing Option

Purchase price: $338,000 capital to be borrowed at i=7%, equal annual payments (Principal + Interest) for three years

Depreciation: three year, MACRS

Annual Maintenance cost: $24,000

Resale value at EOY five: $159,000

Answer 1

	Cost of Buying =
	Annual Loan payment =			Loan Amount/(PVAF(Intt. Rate, n))
				338000/PVAF(7%,3)
				128795.463
	Annual Tax Savings From maintainance =
				Maintainance cost x Tax Rate
				24000* 38%
				9120
	Depreciation =		Cost x Rate for the year
	Year		1	2	3	4
	Rate		33.33%	44.45%	14.81%	7.41%
	Depreciation =		112666.667	150241	50057.8	25034.53333
	Tax Saings	Dep. X Tax rate	42813.3333	57091.58	19021.964	9513.122667
	Loan Repayment schedule -
	Year	0	1	2	3	4	5
	Balance	0	338000.00	232864.54	120369.59	0.00	0
	Annual Payment	0	128795.46	128795.46	128795.46	0.00	0
	Interest	0	23660.00	16300.52	8425.87	0.00	0
	Principle	0	105135.46	112494.95	120369.59	0.00	0
	Interest Tax savings	0	8990.80	6194.20	3201.83	0.00	0
	Net Cash flows(Outflow) -
	Annual Loan payments		-128795.5	-128795.5	-128795.5	0.0	0
	Post tax Maintainance cost	24000 x (1-38%)	-14880.0	-14880.0	-14880.0	-14880.0	-14880.0
Less:	Tax Saings	Depreciation	42813.3	57091.6	19022.0	9513.1	0
Less:	Interest Tax savings		8990.8	6194.2	3201.8	0.0	0
Add:	Post tax salvage value	159000x(1-0.38)					98580
	NCF =	(negative cashflows)	-91871.3	-80389.7	-121451.7	-5366.9	83700.0
	PV Factor @ 9%		0.917	0.842	0.772	0.708	0.650
	PV of NCF		-84285.6	-67662.4	-93783.0	-3802.0	54399.26
	NPV =		-195133.8
	Cost Of Leasing
	Year	Lease rentals	Tax savings on lease rentals	Deposit	Net cashhflow	PV Factor @ 9%	Pv of Post tax cashflow
	0	-57000		-82000	-139000	1	-139000
	1	-57000	-21660		-35340	0.917431193	-32422
	2	-57000	-21660		-35340	0.841679993	-29745
	3	-57000	-21660		-35340	0.77218348	-27289
	4	-57000	-21660		-35340	0.708425211	-25035.7
	5		-21660	82000	103660	0.649931386	67371.89
							-186120
	Leasing will cost less therefore we must take lease option