Question

In: Finance

Lease versus purchase: JLB Corporation is attempting to determine whether to lease or purchase research equipment....

Lease versus purchase: JLB Corporation is attempting to determine whether to lease or purchase research equipment. The firm is in the 28​% tax​ bracket, and its​ after-tax cost of debt is currently 9​%. The terms of the lease and of the purchase are as​ follows: Lease: Annual​ end-of-year lease payments of ​$28,000 are required over the​ 3-year life of the lease. All maintenance costs will be paid by the​ lessor; insurance and other costs will be borne by the lessee. The lessee will exercise its option to purchase the asset for ​$5,000 at termination of the lease. Ignore any future tax benefit associated with the purchase of the equipment at the end of year 3 under the lease option.

Purchase: The research​ equipment, costing ​$65,000 can be financed entirely with a 16% loan requiring annual​ end-of-year payments of ​$28,942 for 3 years. The firm in this case will depreciate the equipment under MACRS using a​ 3-year recovery period. ​ (See (BELOW) for the applicable depreciation​ percentages.) The firm will pay ​1,800 per year for a service contract that covers all maintenance​ costs; insurance and other costs will be borne by the firm. The firm plans to keep the equipment and use it beyond its​ 3-year recovery period. 

a. The after-tax cash outflow associated with the lease in in year 1 is ___

b. The after-tax cash outflow associated with the lease in in year 2 is ___

c. The after-tax cash outflow associated with the lease in in year 3 is ___

d. The after-tax cash outflow associated with the purchase in in year 1 is ___

e. The after-tax cash outflow associated with the purchase in in year 2 is ___

f. The after-tax cash outflow associated with the purchase in in year 3 is ___

g. The total present value of the after-tax cash outflows associated with the lease is ___

h. The total present value of the after-tax cash outflows associated with the purchase is ___

Solutions

Expert Solution

a. The after-tax cash outflow associated with the lease in in year 1 is -$20161

b. The after-tax cash outflow associated with the lease in in year 2 is -$20161

c. The after-tax cash outflow associated with the lease in in year 3 is -$26161

d. The after-tax cash outflow associated with the purchase in in year 1 is -$21320

e. The after-tax cash outflow associated with the purchase in in year 2 is -$20068

f. The after-tax cash outflow associated with the purchase in in year 3 is -$26424

g. The total present value of the after-tax cash outflows associated with the lease is -$54,894

h. The total present value of the after-tax cash outflows associated with the purchase is -$43023

CALCULATION

Calculation of the After-Tax Cash Flows associates with each alternative, Lease or Buy.

(i) Lease Option :

Year

Lease   Payments (A)

Tax Benefit on Lease Payments (B = A * 28%)

Net Annual Cash Flow

1

-$28,000

$7,840

-$20161

2

-$28,000

$7,840

-$20161

3

-$28,000

$7,840

-$20161

3

-$5,000

-

-$5,000

(i) Buy Option :

Year

Payment (A)

Interest (as per Amortization Table Below)

Tax Benefit on Interest (B = Interest * 28%)

Depreciation (C)

Tax Benefit on Depreciation (D = C * 28%)

Maintenance Cost (E)

Tax Benefit on Maintenance Cost (F = E * 28%)

Net Annual Cash Flow (A+B+D+E+F)

1

​-$28,9

42

$10,400

$2912

$21450

$6006

-$1,800

$504

-$21320

2

​-$28,9

42

$7433

$2081

$28892

$8089

-$1,800

$504

-$20068

3

-​$28,9

42

$3,993

$1118

$9627

$2696

-$1,800

$504

-$26424

Loan Amortization Table

Year

Opening Balance

Payment

Interest (Opening Balance * 16%)

Principal Repayment (Payment - Interest)

Closing Balance (Opening Balance - Principal Repayment

1

$65,000

​$28,942

$10,400

$18542

$46,458

2

$46,458

​$28,942

$7433

$21,509

$24949

3

$24,949

​$28,942

$3,993

$24,949

Nil

Calculation of the Present Value of Cash Outflows, using the after-tax cost of debt.

(i) Lease Option :

Year

Net Annual Cash Flow

PVF @ 9%

Present Value of Annual Cash Flow

1

-$20161

0.91743

-$18,496

2

-$20161

0.84168

-$16969

3

-$20161

0.77218

-$15568

3

-$5,000

0.77218

-$3,861

Present Value of the Total Annual Cash Flows

-$54,894

(ii) Buy Option :

Year

Net Annual Cash Flow

PVF @ 9%

Present Value of Annual Cash Flow

1

-$15,565

0.91743

-$14280

2

-$13,873

0.84168

-$11677

3

-$22,100

0.77218

-$17066

Present Value of the Total Annual Cash Flows

-$43023


Related Solutions

Lease versus purchase   JLB Corporation is attempting to determine whether to lease or purchase research equipment....
Lease versus purchase   JLB Corporation is attempting to determine whether to lease or purchase research equipment. The firm is in the 26​% tax​ bracket, and its​ after-tax cost of debt is currently 9​%. The terms of the lease and of the purchase are as​ follows: Lease  Annual​ end-of-year lease payments of $30,000 are required over the​ 3-year life of the lease. All maintenance costs will be paid by the​ lessor; insurance and other costs will be borne by the lessee....
Lease versus purchase JLB Corporation is attempting to determine whether to lease or purchase research equipment....
Lease versus purchase JLB Corporation is attempting to determine whether to lease or purchase research equipment. The firm is in the 21% tax bracket, and its after-tax cost of debt is currently 8%. The terms of the lease and of the purchase are as follows: Lease Annual end-of-year lease payments of $25,200 are required over the 3-year life of the lease. All maintenance costs will be paid by the lessor; insurance and other costs will be borne by the lessee....
Thomas Corporation is evaluating whether to lease or purchase equipment. Its tax rate is 21% ....
Thomas Corporation is evaluating whether to lease or purchase equipment. Its tax rate is 21% . The company expects to use the equipment for 4 years, with no expected salvage value. The purchase price is $2 million and MACRS depreciation, 3-year class, will apply. If the company enters into a 4-year lease, the lease payment is $460,000 per year, payable at the beginning of each year. If the company purchases the equipment it will borrow from its bank at an...
Lease versus borrow to purchase It is time for the renewal of existing photocopying equipment at...
Lease versus borrow to purchase It is time for the renewal of existing photocopying equipment at Runt Ltd. The current equipment is worth $14,500. New equipment will cost $135,000. The $120,000 can be borrowed from the local bank at 5 percent interest with annual payments at the end of each of five years. The CCA rate on the equipment would be 20 percent. The equipment will be salvaged in 5 years for $30,000. An annual maintenance expense of $2,000 would...
Angie Corporation is evaluating whether to lease or purchase equipment. Its tax rate is 30 percent.  If...
Angie Corporation is evaluating whether to lease or purchase equipment. Its tax rate is 30 percent.  If the company purchases the equipment for $2,000,000 it will depreciate it over 4 years, using straight-line depreciation. No salvage value is expected.  If the company enters into a 4-year lease, the lease payment is $600,000 per year, payable at the beginning of each year. If the company purchases the equipment it will borrow from its bank at an interest rate of 10 percent.   Calculate the...
Angie Corporation is evaluating whether to lease or purchase equipment. Its tax rate is 30 percent.  If...
Angie Corporation is evaluating whether to lease or purchase equipment. Its tax rate is 30 percent.  If the company purchases the equipment for $2,000,000 it will depreciate it over 4 years, using straight-line depreciation. No salvage value is expected.  If the company enters into a 4-year lease, the lease payment is $600,000 per year, payable at the beginning of each year. If the company purchases the equipment it will borrow from its bank at an interest rate of 10 percent.   Calculate the...
Harris Corporation is evaluating whether to lease or purchase equipment. Its tax rate is 25 percent....
Harris Corporation is evaluating whether to lease or purchase equipment. Its tax rate is 25 percent. The purchase price is $2.4 million, required modifications to the equipment will cost $100,000. The company would depreciate the equipment over 4 years, using straight-line depreciation. A 4-year lease calls for a payment of $750,000 at the beginning of each year.   If the equipment is purchased, the company will borrow from its bank at an interest rate of 10 percent. a. Calculate the cost...
Emerson Corp. is trying to decide whether to lease or purchase a piece of equipment needed...
Emerson Corp. is trying to decide whether to lease or purchase a piece of equipment needed for the next five years. The equipment would cost $505,000 to purchase, and maintenance costs would be $20,300 per year. After five years, Emerson estimates it could sell the equipment for $100,500. If Emerson leases the equipment, it would pay $151,900 each year, which would include all maintenance costs. Emerson’s hurdle rate is 15%. (Future Value of $1, Present Value of $1, Future Value...
Emerson Corp. is trying to decide whether to lease or purchase a piece of equipment needed...
Emerson Corp. is trying to decide whether to lease or purchase a piece of equipment needed for the next five years. The equipment would cost $502,000 to purchase, and maintenance costs would be $20,700 per year. After five years, Emerson estimates it could sell the equipment for $100,800. If Emerson leases the equipment, it would pay $152,000 each year, which would include all maintenance costs. Emerson’s hurdle rate is 15%. a. What is the net present value of the cost...
Sanders Limited is considering whether to lease its equipment as an alternative to borrowing to purchase...
Sanders Limited is considering whether to lease its equipment as an alternative to borrowing to purchase it. The equipment will cost $230,000. This amount can be borrowed from a local bank at 8.5% interest with annual payments amortized over 6 years. Payments would be at the end of the year. The CCA rate on this equipment would be 25%, and the expected salvage at the end of 6 years is $33,000. Alternatively, lease payments of $47,000 could be made each...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT