Question

You are the financial advisor to Mr. Agirich who has been having his 400 acres custom harvested at a cost of $22.00 per acre. However, he has been informed that the price is going up to $27.00 next year. Moreover, he is considering the acquisition of his

own machine, either through leasing or cash purchase.
If he shifts from custom harvesting to operating the machine himself, he will need to hire one extra man for 14 days each year

at $75.00 per day. Moreover, he estimates that operating costs, including fuel, lubrication, repair, insurance, etc. will be $8.00 per acre. The cost of machine purchase is $50,000. The economic life of the machine is projected to be seven years, with no salvage value. He plans to borrow 80% of the purchase price (20% down payment) using a loan that is fully amortized at 10% over three years (annual payments).

He can also obtain control of this machine through a financial lease for $9,600 per year for 7 years, due at the beginning of each year. He will assume responsibility for repair, insurance, and operation under this financial lease just as though he purchased the machine. Assume that the tax deduction due to the lease can be taken at the beginning of the year.

He projects his tax rate on marginal income to be 15%. He uses 5-year straight-line depreciation on the farm machinery he owns. He has other investment opportunities that promise to pay 10%. Assume that the inflation rate is 0%.

PROBLEM
Assuming all three methods of control (custom hire, leasing, or purchase) are otherwise satisfactory to him, which would be the best investment?

What is after-tax terminal value of the machine if the machine is purchased (absolute value)?

What is the present value of annual operating and labor costs if the machine is purchased (absolute value)?

What is the present value of the tax savings from depreciation if the machine is purchased (absolute value)?

What is the net present value if the machine is purchased (absolute Value)?

What is annual equivalent if the machine is purchased (absolute value)?

What is the annual after-tax cost of the lease at the beginning of the first year (absolute value)?

What is the annual after-tax cost of the lease and additional operating expenses at the beginning of the second year (absolute value)?

What is the annual after-tax cost of the additional operating expenses during the seventh year (absolute value)?

What is the Net Present Value if the machine is leased (absolute value)?

What is the annuity equivalent if the machine is leased (absolute value)?

Purchasing the Machine has a lower cost so you would choose to purchase the machine?

Answer 1