Suppose Proctor? & Gamble? (P&G) is considering purchasing $17million in new man

Question

Suppose Proctor? & Gamble? (P&G) is considering purchasing $17million in new manufacturing equipment. If it purchases the? equipment, it will depreciate it for tax purposes on a? straight-line basis over five? years, after which the equipment will be worthless. It will also be responsible for maintenance expenses of $1.00 million per? year, paid in each of years 1 through 5. It can also lease the equipment under a true tax lease for $ 4.7 million per year for the five? years, in which case the lessor will provide necessary maintenance. Assume? P&G's tax rate is 40%?,its borrowing cost is 6.0%?

a. What is the NPV associated with leasing the equipment versus borrowing and buying? it?

b. What is the? break-even lease rate-- that ?is, what lease amount could? P&G pay each year and be indifferent between leasing and buying through? borrowing?

Explanation / Answer

a:

NPV of buying= -Initial cost + Tax*Cost/ Life * PVIFA(6%,5) – Maintenance*PVIFA(6%,5)

= -17000000+ 0.4*17000000/6 * 4.212- 1000000*4.212

=-16438400

NPV of leasing = -4700,000* PVIFA(6%,5)

= -4700000*4.212

=-19796400

The cost of buying is lesser and hence the equipment should be purchased.

b) Break even lease = PV of buying/ PVIFA 6%,5

= -16438400/ 4.212

= - $ 3,902,754

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