Question

Wilayah Leasing & Credit Berhad is arranging for a 6-year lease financing facility for a new boiler costing $5,000,000. Assume the following information:-

• Equipment falls under the MACRS 5-year class
• An estimated annual maintenance expense of $150,000 is paid at the end of each year and this cost is expected to increase at a rate of 5% annually from year 4 onwards.
• Annual insurance premium is calculated at a rate of 1.65% of the insured value. For the first year, the equipment will be insured for $5.0 million. For the subsequent years, the book value of the asset is taken as the yearly insured value. Annual insurance premium are being paid at the beginning of the year.
• Under the proposed lease terms, the lessor must pay for maintenance and insurance
• The tentative lease payment calls for a six beginning-of-the-year payments of $650,000
• Corporate tax is at 35%
• Wilayah Leasing will invest 75% of its fund to purchase the equipment and finance the remaining cost with a bank loan of 6.75% nominal rate, on yearly rests, payable in 6 years     (ordinary annuity)
• At the end of the lease period, the equipment can be sold for $500,000.

Should Wilayah Leasing proceed with this arrangement to finance its customer?

Please show every single step.

Answer 1

		Boiler Cost	$5,000,000
		Borrowed amount=25%*5000000=	$1,250,000
		Initial Cash Flow (Year 0)	($3,750,000)
		5 year MACRS
		Equipment Cost=$5000000	$5,000,000
			A	B=A*$5000000	C=B*35%	D	E=5000000-D
			Depreciation	Amount of	Depreciation	Accumulated	Book Value
		Year	Rate	Depreciation	Tax Shield	Depreciation	End of year
		1	20.00%	$1,000,000	$350,000	$1,000,000	$4,000,000
		2	32.00%	$1,600,000	$560,000	$2,600,000	$2,400,000
		3	19.20%	$960,000	$336,000	$3,560,000	$1,440,000
		4	11.52%	$576,000	$201,600	$4,136,000	$864,000
		5	11.52%	$576,000	$201,600	$4,712,000	$288,000
		6	5.76%	$288,000	$100,800	$5,000,000	$0
		Before tax Salvage Value	$500,000
		After tax Salvage Value=500000*(1-0.35)	$325,000
		INTEREST AND PRINCIPAL REPAYMENT ON AMOUNT BORROWED
	Pv	Amount Borrowed =0.25*5000000=	$1,250,000
	Nper	Number of years of repayment	6
	Rate	Interest Rate	6.75%
	PMT	Annual repayment in five equal instalments	$260,224	(Using PMT function of excelwith Rate=6.75%,Nper=6, Pv=-1250000
		REPAYMENT SCHEDULE
		Year		1	2	3	4	5	6
	A	Beginning Balance		$1,250,000	$1,074,151	$886,432	$686,042	$472,125	$243,770
	B	Amount of annual payment		$260,224	$260,224	$260,224	$260,224	$260,224	$260,224
	C=A*11%	Interest		$84,375	$72,505	$59,834	$46,308	$31,868	$16,454
	D=B-C	Principal		$175,849	$187,719	$200,390	$213,916	$228,356	$243,770
	E=A-D	Ending Balance		$1,074,151	$886,432	$686,042	$472,125	$243,770	$0
		Annual Savings	$250,000
	N	Year	0	1	2	3	4	5	6
	a	Initial Cash Flow	($3,750,000)
		Annual Cash Inflows:
	.(1)	Annual Lease Payment	$650,000	$650,000	$650,000	$650,000	$650,000	$650,000
	,(2)	Interest Cost for amount borrowed		-$84,375	-$72,505	-$59,834	-$46,308	-$31,868	-$16,454
	.(3)	Annual Maintenance Cost		-$150,000	-$150,000	-$150,000	-$157,500	-$165,375	-$173,644
	.(4)	Insurance Cost(1.65% Book Value)	($82,500)	-$66,000	-$39,600	-$23,760	-$14,256	-$4,752
	.(5)=(1)+(2)+(3)+(4)	Earning Before Taxes(Excluding Depreciation)	$567,500	$349,625	$387,895	$416,406	$431,936	$448,005	-$190,098
		Taxes(35%)	($198,625)	-$122,369	-$135,763	-$145,742	-$151,178	-$156,802	$66,534
		After tax earning (Excluding Depreciation)	$368,875	$227,256	$252,132	$270,664	$280,759	$291,203	-$123,564
		Add: depreciation tax shield		$350,000	$560,000	$336,000	$201,600	$201,600	$100,800
	b	Total Operating Cash Flow	$368,875	$577,256	$812,132	$606,664	$482,359	$492,803	-$22,764
	c	Cash flow for repayment of principal		-$175,849	-$187,719	-$200,390	-$213,916	-$228,356	-$243,770
	d	After tax salvage value							$325,000
	CF=a+b+c+d	PROJECT NET CASH FLOW	-$3,381,125	$401,407	$624,413	$406,274	$268,442	$264,447	$58,466
		Discount Rate =after tax borrowing rate =6.75*(1-0.35)	4.4%							SUM
	PV=CF/(1.044^N)	Present Value of Net Cash Flow at 4.4% discount	-$3,381,125	$384,490	$572,889	$357,040	$225,969	$213,224	$45,155	-$1,582,358
	NPV=SUM of PV	Net Present Value	-$1,582,358
		NPV is negative
		Wilayah Leasing SHOULD NOT proceed with this arrangement