High electricity costs have made Farmer Corporation’s chicken-plucking machine e

Question

High electricity costs have made Farmer Corporation’s chicken-plucking machine economically worthless. Only two machines are available to replace it. The International Plucking Machine (IPM) model is available only on a lease basis. The lease payments will be $79,000 for five years, due at the beginning of each year. This machine will save Farmer $29,000 per year through reductions in electricity costs. As an alternative, Farmer can purchase a more energy-efficient machine from Basic Machine Corporation (BMC) for $400,000. This machine will save $39,000 per year in electricity costs. A local bank has offered to finance the machine with a $400,000 loan. The interest rate on the loan will be 9 percent on the remaining balance and will require five annual principal payments of $80,000. Farmer has a target debt-to-asset ratio of 65 percent. Farmer is in the 34 percent tax bracket. After five years, both machines will be worthless. The machines will be depreciated on a straight-line basis.

What is the NAL of leasing? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

How much debt is displaced by this lease? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Explanation / Answer

NAL of leasing is $53,000.

$79,000 is displaced by this lease.

year IPM BMC lease payment/purchase cost 395,000 400,000 savings in electricity (145,000) (195,000) 1 Interest payment on loan 36,000 2 28,800 3 21,600 4 14,400 5 7,200 Total cost 250,000 313,000

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