Question

In: Finance

Lease vs Buy Purchase 10 million Depreciate 5 years straight line to zero Expected salvage 2...

Lease vs Buy

Purchase 10 million

Depreciate 5 years straight line to zero

Expected salvage 2 million

Tax rate 40%

Lease payments 2 million at beginning of year

Cost of equity 10%

Cost of debt 5%

D/E = 1

Cost of capital?

Cost of ownership?

Value of dep tax shield

Value of ownership?

Value of lease?

Solutions

Expert Solution

Cost of capital

Cost of capital = Cost of equity * Weight + After tax cost of debt * Weight

= 10% * 0.5 + 5%(1-0.4) * 0.5

= 6.5%

Cost of ownership

Cost of ownership = Purchase cost- Tax savings on depreciation - Salvage value

= $10 million - (40%*$2 million*5 years) - $2 million

= $4 million

Value of dep tax shield

Year 1 2 3 4 5 Total
Depreciation $             2 $             2 $             2 $             2 $             2 $    10.00
Tax savings @ 40% $       0.80 $       0.80 $       0.80 $       0.80 $       0.80 $       4.00
PVF @ 6.5%           0.94           0.88           0.83           0.78           0.73
Value of dep. tax shield $       0.75 $       0.71 $       0.66 $       0.62 $       0.58 $       3.32

Value of ownership

Year 0 1 2 3 4 5 Total
Purchase cost     (10.00) $ (10.00)
Tax savings @ 40%               -             0.80           0.80           0.80           0.80           0.80 $       4.00
Salvage value               -                  -                  -                  -                  -             2.00 $       2.00
Cost of ownership     (10.00)           0.80           0.80           0.80           0.80           2.80 $    (4.00)
PVF @ 6.5% 1           0.94           0.88           0.83           0.78           0.73
Value of ownership     (10.00)           0.75           0.71           0.66           0.62           2.04 $    (5.22)

Value of lease

Year 0 1 2 3 4 Total
Lease payments          2.00           2.00           2.00           2.00           2.00 $    10.00
PVF @ 6.5% 1           0.94           0.88           0.83           0.78
Value of lease          2.00           1.88           1.76           1.66           1.55 $       8.85

jeff jeffy answered 2 years ago
Next > < Previous

Related Solutions

A project requires an initial investment of $1,000,000 and is depreciated straight-line to zero salvage over...
A project requires an initial investment of $1,000,000 and is depreciated straight-line to zero salvage over its 10-year life. The project produces items that sell for $1,000 each, with variable costs of $700 per unit. Fixed costs are $350,000 per year.  What is the accounting break-even quantity? o Q = (FC + D)/(P – v)  What is the operating cash flow at accounting break-even? o OCF= [PQ - vQ – FC – D] + D  What is...
A project requires an initial investment of $1,000,000 and is depreciated straight-line to zero salvage over...
A project requires an initial investment of $1,000,000 and is depreciated straight-line to zero salvage over its 10-year life. The project produces items that sell for $1,000 each, with variable costs of $700 per unit. Fixed costs are $350,000 per year. What is the accounting break-even quantity and financial break-even quantity (assume 10% as discount rate)? I'm not too sure how to go about this question. Any help?
A project requires an initial investment of $1,000,000 and is depreciated straight-line to zero salvage over...
A project requires an initial investment of $1,000,000 and is depreciated straight-line to zero salvage over its 10-year life. The project produces items that sell for $1,000 each, with variable costs of $700 per unit. Fixed costs are $350,000 per year. What is the financial break-even quantity assuming 10% as discount rate?
A project requires an initial investment of $1,000,000 and is depreciated straight-line to zero salvage over...
A project requires an initial investment of $1,000,000 and is depreciated straight-line to zero salvage over its 10-year life. The project produces items that sell for $1,000 each, with variable costs of $700 per unit. Fixed costs are $350,000 per year. 1) What is the accounting break-even quantity? What is theoperating cash flow at accounting break-even? What is degree of operating leverage (DOL) at that output level?And what does the DOL indicate? 2) What is the cash flow break-even quantity?...
A new product requires an initial investment of $3.5 million and will be depreciated to an expected salvage of zero over 7 years.
A new product requires an initial investment of $3.5 million and will be depreciated to an expected salvage of zero over 7 years. The price of the new product is expected to be $35,000, and the variable cost per unit is $27,000. The fixed cost is $1.5 million. Assume that discount rate is 15%. Calculate accounting, cash, and financial break-evens.
Net cost of new equipment: 1,000,000 life: 10 years, no salvage value, straight line depreciation Forecasted...
Net cost of new equipment: 1,000,000 life: 10 years, no salvage value, straight line depreciation Forecasted sales volume: 10,000 units per year variable costs: 60 dollars per unit fixed: 30 dollars per unit 150,000 per year Taxes are 40% and cost of capital is 14% Break even sales are said to be 8,333.3. Sales are expected to be 10,000 units and project is expected to generate net income of 30,000 per year. You are told it should be accepted. Revenue...
A company purchased a building at the beginning of the year for $200,000 and is using straight-line depreciation to depreciate it over 20 years.
  A company purchased a building at the beginning of the year for $200,000 and is using straight-line depreciation to depreciate it over 20 years. The salvage value of the building is $50,000. Prepare the adjusting entry to record the depreciation expense for the current year. DEBIT: Accumulated Depreciation for $5,000; CREDIT: Depreciation Expense for $5,000 DEBIT: Accumulated Depreciation for $7,500; CREDIT: Depreciation Expense for $7,500 DEBIT: Depreciation Expense for $5,000; CREDIT: Accumulated Depreciation for $5,000 DEBIT: Depreciation Expense for...
AA purchased a van (cost: $50,000, salvage value: $5,000, useful life: 5 years). 1. Under straight-line...
AA purchased a van (cost: $50,000, salvage value: $5,000, useful life: 5 years). 1. Under straight-line method, how much is the book value at the end of 3rd year of its useful life? $18,000 $20,000 $23,000 $27,000 2. Under double-declining balance method, how much is the book value at the end of 5thyear? $2,333 $5,432 $6,221 None of the above 3. Under sum-of-years’ digits method, how much is the accumulated depreciation at the end of 3rd year? 4. Under sum-of-years’...
company purchase a machine costing $100,000 for 5years without salvage value. using straight line method and...
company purchase a machine costing $100,000 for 5years without salvage value. using straight line method and double declining method macrs Daniels company purchased a machine costing $100,000 for 5 years useful life without salvage value. suing straight line and double declining method macrs
This venture will require an initial outlay of $537,800 to buy a refrigerated storage unit, which can be depreciated (straight-line) to a salvage value of $140,000 in 15 years.
This venture will require an initial outlay of $537,800 to buy a refrigerated storage unit, which can be depreciated (straight-line) to a salvage value of $140,000 in 15 years. In addition, she will need $80,000 in working capital during the 15 years of the project. Annual sales are estimated to be $250,000 and annual expenses $150,000. She also estimates that the marginal tax rate and RRR will be 28% and 8%, respectively, during the lifetime of project. Using the given...
ADVERTISEMENT
Subjects
ADVERTISEMENT
Latest Questions
ADVERTISEMENT