Question

A HCA hospital in Colorado plans to obtain a new MRI that costs $1.5 million and has
an estimated four-year useful life. It can obtain a bank loan for the entire amount and buy the MRI,
or it can obtain a guideline lease for the equipment. Assume that the following facts apply to the decision:
- The MRI falls into the three-year class for tax depreciation, so the MACRS allowances are 0.33, 0.45,
0.15, and 0.07 in Years 1 through 4, respectively.
- Estimated maintenance expenses are $75,000 payable at the beginning of each year whether the MRI is
leased or purchased.
- HCA's marginal tax rate is 40 percent.
- The bank loan would have an interest rate of 15 percent.
- If leased, the lease payments would be $400,000 payable at the end of each of the next four years.
- The estimated residual (and salvage) value is $250,000.
a. What are the NAL and IRR of the lease? Interpret each value.

Answer 1

a)

	Year 0	Year 1	Year 2	Year 3	Year 4
Cost of owning
Net Purchase price	$      15,00,000
Maintenance Expenses	$            75,000	$           75,000	$           75,000	$       75,000
Tax Savings on Maintenance Expenses	$          -30,000	$         -30,000	$         -30,000	$      -30,000
Depreciation Tax savings		$      -1,98,000	$      -2,70,000	$      -90,000	$         -42,000
Salvage Value					$      -2,50,000
Tax on Salvage Value					$        1,00,000
Net Cash Flow	$      15,45,000	$      -1,53,000	$      -2,25,000	$      -45,000	$      -1,92,000
Cost of leasing
Lease Payment		$        4,00,000	$        4,00,000	$    4,00,000	$        4,00,000
Tax Savings on Lease Payments		$      -1,60,000	$      -1,60,000	$   -1,60,000	$      -1,60,000
Maintenance Expenses	$            75,000	$           75,000	$           75,000	$       75,000
Tax Savings on Maintenance Expenses	$          -30,000	$         -30,000	$         -30,000	$      -30,000
Net Cash Flow	$           45,000	$       2,85,000	$       2,85,000	$    2,85,000	$       2,40,000
Net Advantage of leasing
PVF @15% or 9% after tax	1.0000	0.9174	0.8417	0.7722	0.7084
Present Value of Cost of Owning	$      10,44,489
Present Value of Cost of leasing	$        9,36,441
Net Advantae of Leasing	$        1,08,048

Net advantage of Leasing  = $108,048

The IRR of the above cash flow is

Year	Particulars	Amount
0	Cost of Asset	$14,70,000
1	Lease Rental+Taxsavings on Depreciation	$ -6,28,000
2	Lease Rental+Taxsavings on Depreciation	$ -7,00,000
3	Lease Rental+Taxsavings on Depreciation	$ -5,20,000
4	Lease Rental+Taxsavings on Depreciation+Salvage avlue after tax	$ -5,92,000
	IRR at 9%guess (after tax)	24.57%