Question

Hoffman Mining Limited needs the use of a large loader truck to transport mining material extracted from its Papua New Guinea gold mine to the associated processing and extraction plant. The cost of purchasing a new Caterpillar loader truck is $500,000. The company can obtain a 10-year interest and principal loan at an 8.50% per annum interest rate from the Bank of PNG Limited to fund the $500,000 purchase cost. If acquired, the loader truck will be depreciated on a straight-line basis over the 10-year asset life. Assume the asset will have no disposal value at the end of the mining project. Based on the above loan terms, the debt repayment schedule will be as follows:

Year	Beginning balance	Interest	Total	Loan payment	Ending Balance
1	$500,000	$42,500	$542,500	$76,204	$466,296
2	$466,296	$39,635	$505,931	$76,204	$429,727
3	$429,727	$36,527	$466,254	$76,204	$390,050
4	$390,050	$33,154	$423,204	$76,204	$347,000
5	$347,000	$29,495	$376,495	$76,204	$300,291
6	$300,291	$25,525	$325,816	$76,204	$249,612
7	$249,612	$21,217	$270,829	$76,204	$194,625
8	$194,625	$16,543	$211,168	$76,204	$134,964
9	$134,964	$11,472	$146,436	$76,204	$70,232
10	$70,232	$5,972	$76,204	$76,204	$0

Alternatively, the company can lease the loader truck through the Caterpillar PNG Mining Finance Company on a 10-year lease term based on annual lease payments made in advance (at the beginning of the year) of $60,000. Hoffman Mining Limited has a corporate tax rate of 30%. Assume that the tax benefits from borrowing or leasing payments / allowable deductions are obtained at the end of same year that payments are made.

Should Hoffman Mining Limited borrow-and-buy or lease the Caterpillar loader truck? (Note: Net advantage of leasing (NAL) = (PV of Tax Benefits from Leasing – PV of Tax Benefits from Borrowing) – Opportunity Cost of Leasing)

Answer 1

Cost to be the part of Income statement if truck Purchase
	1	2	3	4	5	6	7	8	9	10
Interest Expense	42500	39635	36527	33154	29495	25525	21217	16543	11472	5972
Depreciation	50000	50000	50000	50000	50000	50000	50000	50000	50000	50000
Total	92500	89635	86527	83154	79495	75525	71217	66543	61472	55972
Tax @ 30%	27750	26890.5	25958.1	24946.2	23848.5	22657.5	21365.1	19962.9	18441.6	16791.6
PV factor @ 8.5%	0.921659	0.849455	0.782908	0.721574	0.665045	0.612945	0.564926	0.520669	0.47988	0.442285
PV	25576	22842	20323	18001	15860	13888	12070	10394	8850	7427
Sum of all PV	155230
Cost to be the part of Income statement if on lease
	1	2	3	4	5	6	7	8	9	10
Lease Expense	60000	60000	60000	60000	60000	60000	60000	60000	60000	60000
Tax @ 30%	18000	18000	18000	18000	18000	18000	18000	18000	18000	18000
PV factor @ 8.5%	0.921659	0.849455	0.782908	0.721574	0.665045	0.612945	0.564926	0.520669	0.47988	0.442285
PV	16590	15290	14092	12988	11971	11033	10169	9372	8638	7961
Sum of all PV	118104
PV of opportunity cost	4700	4332	3993	3680	3392	3126	2881	2655	2447	2256
Sum of all PV	33463
Net advantage of leasing (NAL) = (PV of Tax Benefits from Leasing – PV of Tax Benefits from Borrowing) – Opportunity Cost of Leasing)
Net advantage of leasing (NAL) =			-70589		(118104-155230)-33463
Hence net advantage from easing is negative, Hoffman Mining should purchase the assets by availing a loan from PNG Limited.