Question

High electricity costs have made Farmer Corporation’s chicken-plucking machine economically worthless. Only two machines are available to replace it. The International Plucking Machine (IPM) model is available only on a lease basis. The lease payments will be $85,000 for five years, due at the beginning of each year. This machine will save Farmer $31,500 per year through reductions in electricity costs. As an alternative, Farmer can purchase a more energy-efficient machine from Basic Machine Corporation (BMC) for $405,000. This machine will save $34,500 per year in electricity costs. A local bank has offered to finance the machine with a $405,000 loan. The interest rate on the loan will be 6 percent on the remaining balance and will require five annual principal payments of $81,000. Farmer has a target debt-to-asset ratio of 64 percent and a tax rate of 25 percent. After five years, both machines will be worthless. The machines will be depreciated on a straight-line basis.

a.	What is the NAL of leasing? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
b.	How much debt is displaced by this lease? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

    

Answer 1

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