Question

ABC company is considering buying a machine that costs $350,000. The company can finance the purchase with a bank loan at 8%, with equal annual instalments over 10 years. The machine would have a salvage value of $25,000 at the end of 10 years. Alternatively, the machine could be leased, with 10 equal annual payments of $50,000, starting today. ABC's tax rate is 35%. The machine belongs to a CCA pool depreciating at 20%. ABC's cost of capital is 11%. The appropriate discount rate is: 5.2% 8% 7.15% 11%

Answer 1

		ALTERNATIVE-1 BUYING WITH BANK FINACE
			Loan amount	$350,000
			Interest Rate	8%
			Present Value (PV) of Cash Flow:
			(Cash Flow)/((1+i)^N)
			i=Discount Rate
			N=Year of Cash Flow
		N	Year	0	1	2	3	4	5	6	7	8	9	10
		PPMT	Principal payment (using excel PPMT function with Rate=8%, Per=N,Nper=10, Pv=-350000)		$24,160	$26,093	$28,181	$30,435	$32,870	$35,499	$38,339	$41,407	$44,719	$48,297
		IPMT	Interest payment (using excel IPMT function with Rate=8%, Per=N,Nper=10, Pv=-350000)		$28,000	$26,067	$23,980	$21,725	$19,290	$16,661	$13,821	$10,754	$7,441	$3,864
		A=-(PPMT+IPMT)	Cash Flow		($52,160)	($52,160)	($52,160)	($52,160)	($52,160)	($52,160)	($52,160)	($52,160)	($52,160)	($52,160)
		B=IPMT*35%	Interest tax shield		$9,800	$9,124	$8,393	$7,604	$6,752	$5,831	$4,837	$3,764	$2,604	$1,352
		C	Book value at beging of year		$350,000	$280,000	$224,000	$179,200	$143,360	$114,688	$91,750	$73,400	$58,720	$46,976
		D=c*20%	Depreciation		$70,000	$56,000	$44,800	$35,840	$28,672	$22,938	$18,350	$14,680	$11,744	$9,395
		E	Book value at End of year		$280,000	$224,000	$179,200	$143,360	$114,688	$91,750	$73,400	$58,720	$46,976	$37,581
		F=D*35%	Depreciation tax shield		$24,500	$19,600	$15,680	$12,544	$10,035	$8,028	$6,423	$5,138	$4,110	$3,288
		G	Salvage value in year 10											$25,000
		H=G-E	Gain/(Loss) on salvage											($12,581)
		I=H*35%	Tax /(tax saving)on gain /(loss) on salvage											($4,403)
		J=G-I	Cash flow from salvage											$29,403
	Discount Rate	K=A+B+F+J	Net Cash Flow		($17,860)	($23,437)	($28,087)	($32,012)	($35,373)	($38,301)	($40,900)	($43,258)	($45,445)	($18,116)	SUM
	5.20%	PV5.2=K/(1.052^N)	Present Value of Net Cash flow at 5.2%		-$16,977	-$21,177	-$24,125	-$26,137	-$27,454	-$28,256	-$28,683	-$28,837	-$28,797	-$10,912	-$241,355
			Net Present Value at 5.2%	-$241,355
	8%	PV8=K/(1.08^N)	Present Value of Net Cash flow at 8%		-$16,537	-$20,093	-$22,297	-$23,530	-$24,075	-$24,136	-$23,865	-$23,371	-$22,734	-$8,391	-$209,030
			Net Present Value at 8%	-$209,030
	7.15%	PV7.15=K/(1.0715^N)	Present Value of Net Cash flow at 7.15%		-$16,669	-$20,413	-$22,832	-$24,286	-$25,045	-$25,308	-$25,222	-$24,896	-$24,410	-$9,081	-$218,161
			Net Present Value at 7.15%	-$218,161
	11%	PV11=K/(1.11^N)	Present Value of Net Cash flow at 11%		-$16,090	-$19,022	-$20,537	-$21,088	-$20,992	-$20,477	-$19,700	-$18,771	-$17,766	-$6,380	-$180,824
			Net Present Value at 11%	-$180,824