You work for Instacart. The company is considering leasing mobile distribution centers to speed up its...

You work for Instacart. The company is considering leasing mobile distribution centers to speed up its delivery services and make them more efficient. The mobile distribution centers cost a total of $4,500,000, and they would be depreciated straight-line to zero over 4 years. Because of their expected extensive use, they will be completely valueless in 4 years. Instacart can lease the mobile distribution centers for $1,350,000 per year for 4 years from another company. Assume that Instacart is in 35% tax rate bracket, and can borrow at 8% before taxes.

(10 points) Should Instacart lease or buy the mobile distribution centers? Show and explain all calculations.

(10 points) Suppose the entire purchase price of the mobile distribution centers is borrowed. The rate on the loan is 8%, and the loan will be repaid in equal installments. Create a lease-vs-buy analysis that explicitly incorporates the loan payments. Show that the NPV of leasing instead of buying is not changed from what it was in (a). Why is this so?? Show and explain all calculations.

Solutions

Expert Solution

Part (a)

Instacart has two alternatives. (1) To acquire the mobile distribution centres out of borrowed funds (2) To acquire the mobile distribution centres on lease basis. The financial implications of these two options can be evaluated as follows :

Option 1 : To acquire the mobile distribution centres out of borrowed funds

In this case Instacart has to pay interest @ 8 % annually and repayment of $4,500,000 at the end of 4th year.

Year	Interest+ Repayment	Depreciation	Tax Shield (4)= 35% of (2+3)	Cash Outflows (5)=2-4	PVF @ 5.2%	PV $
(1)	(2)	(3)	(4)	(5)
1	360,000	1,125,000	519,750	(159,750)	0.9506	(151,858.35)
2	360,000	1,125,000	519,750	(159,750)	0.9036	(144,350.10)
3	360,000	1,125,000	519,750	(159,750)	0.8589	(137,209.28)
4	360,000+4,500,000	1,125,000	519,750	4,340,250	0.8165	3,543,814.13
	PV of Cash Outflows					3,110,396.40

Option 2 : To acquire the mobile distribution centres on lease basis

Year	Rental (1)	Tax Shield (2)	Cash Outflow (1-2)	PV @ 5.2%	PV $
1	1,350,000	472,500	877,500	0.9506	834,151.50
2	1,350,000	472,500	877,500	0.9036	792,909.00
3	1,350,000	472,500	877,500	0.8589	753,684.75
4	1,350,000	472,500	877,500	0.8165	716,478.75
	PV of Cash Outflows				3,097,224.00

As the PV of outflows is less in case of leasing option, Instacart should lease the mobile distribution centres.

Note: PVF of 5.2% is calculated by adjusted the interest rate with tax rate.

jeff jeffy answered 1 year ago

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