Question

Roberts Fabrication and Automation, Inc. (RFA) just completed its Capital Budgeting analysis for a new metallic 3D printing machine that will aid in the design and production of new “classic” and customautomotive components. The NPV is positive and significant, the IRR is well above the 12% project hurdle rate (required return), and RFA has decided to move forward with the project.

The next part of their analysis involves the financing of the machine, that is, whether to purchase, or to lease the machine.

If the printer is purchased:

The initial investment (printer cost, shipping, & installation) is $347,500. RFA expects to borrow this amount from the 4th Tennessee Bank of the Southeast with a term of 4 years and an interest rate of 7.25%. The loan would be fully amortized and call for annual payments at the end of each year. Maintenance costs are predicted to be $20,000 per year. Base on Internal Revenue Service guidelines, the printer will be depreciated using MACRS (half-year convention) and a 5 year class-life. RFA’s tax rate is 31%

The Leasing option:

The printer will be made by Custom Tools of Middle Tennessee. It has offered to lease the printer to RFA as an alternative to the purchase option. Their proposed lease terms are:

•  Lease payments of $89,250 per year beginning on the installation of the printer with a total of 5 payments. (This means payments at t = 0, 1, 2, 3, and 4).

•  The Lease payments above include all maintenance.

  RFA expects to operate this project for 4 years (and no more), regardless of whether is purchases orleases the printer. The printer is expected to have a market value of $42,500 (“salvage value”) at the endof the 4 year project. Consider this to be a guideline lease for IRS purposes.

  Using a blank worksheet (or page of paper) conduct the Lease vs Buy analysis.

a. Using Custom Tools’ proposed lease terms, what is the NAL, and should the 3d printer be leased or

purchased?

b. Using your first analysis (part a.), at what lease payment would the firm be indifferent to either leasing or buying? That is, what annual lease payment results in a NAL=0?

c. The salvage value is the most uncertain cash flow in the analysis. With the additional risk of that cash flow (assume a pre-tax discount rate of 15 percent for this item), what would be the effect of a salvage value risk adjustment on the decision? That is, what is the revised NAL, and decision in this scenario? Note: The salvage value is the only cash flow affected in this scenario.

****Need to have the answer given with full syntax and need the work to be shown.****

Answer 1

a)

Lease VS Buy Analysis

Buy Analysis (Cost Analysis)
	Year 0	Year 1	Year 2	Year 3	Year 4
Initial Investment	$ (347,500.00)
Borrow Money From Bank	$    347,500.00
Interest Rate	7.25%	$   25,193.75	$    25,193.75	$    25,193.75	$   25,193.75
Maintenance Cost		$   20,000.00	$    20,000.00	$    20,000.00	$   20,000.00
Total Cost	$    528,275.00
Depreciation (4 year)	$    305,000.00
Less Salvage Value	$      42,500.00
Less amount saved on Depreciation	$      94,550.00	(305k *31%)
Less Amount saved on Tax Payment due to interest effect	$      56,040.25	(25+20)*31%
Total Cost	$   335,184.75

Assume that there is salvage value of $42,500 then we can't apply MACRS method in firs Analysis

But if we used MARCRS method

Depreciation Calculation as per MACRS
Year	Percentage	Amt of depre	Amount Saved on Tax payment
Year 1	33.33%	$    115,821.75	$                                          35,904.74
Year 2	44.45%	$    154,463.75	$                                          47,883.76
Year 3	14.81%	$       51,464.75	$                                          15,954.07
Year 4	7.41%	$       25,749.75	$                                            7,982.42

Lease payment

Lease payment Analysis
	year 1	year 2	year 3	year 4	year 5
Lease payment	$      89,250.00	$   89,250.00	$       89,250.00	$                      89,250.00	$   89,250.00
Benefit on Tax payment	$      27,667.50	$   27,667.50	$       27,667.50	$                      27,667.50	$   27,667.50
Cost per year	$      61,582.50	$   61,582.50	$       61,582.50	$                      61,582.50	$   61,582.50
Total cost	$    307,912.50

NAL should be = $335,184.75 - 307,912.50

= $27,272.25

But if we use depreciation under MARCRS method, before that please see the below brief about depreciation :

When using MACRS, an asset does not have any salvage value. This is because the asset is always depreciated down to zero as the sum of the depreciation rates for each category always adds up to 100%. When calculating depreciation expense for MACRS, always use the original purchase price of the asset as the depreciable base for each period. Note that you depreciate each category for one year longer than its classification period. For example, depreciate an asset classified under 3-Year MACRS for 4 years. Then depreciate an asset classified under 5-Year MACRS for 6 years, and so on

NAL should be = $364,509.75 - $ 307,912.50

= $ 56,597.25

b)

Using your first analysis (part a.), at what lease payment would the firm be indifferent to either leasing or buying? That is, what annual lease payment results in a NAL=0?

If NAL will zero if buy price is equal to lease price so

= $364,509.75 divided by 4 gives NAL zero (As per MARCRS depreciation Method)

that is lease payment of $91,127.44

c)c. The salvage value is the most uncertain cash flow in the analysis. With the additional risk of that cash flow (assume a pre-tax discount rate of 15 percent for this item), what would be the effect of a salvage value risk adjustment on the decision? That is, what is the revised NAL, and decision in this scenario?

If there is a 15% additional discount on salvage value there is risk that NAL gap also increases as difference

will become $33,647.25. Salvage value become $ 36,125