Question
In: Finance
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.
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