Question 17 5 pts Jim owns a lawn care service. He would like to obtain a new he

Question

Question 17 5 pts Jim owns a lawn care service. He would like to obtain a new heavy duty trailer to haul his equipment and materials from job to job. He's found one that will suit his needs. The purchase price is $8,500. Jim is in a 28% tax bracket and sales taxes are 5%. The cost of capital for Jim to purchase the trailer is 8%. The trailer qualifies for 5 year MACRS depreciation method. Jim intends on using the equipment for 60 months. The salvage value of the trailer at the end of the use period is $4500. Jim has also found a dealer that is willing to lease the trailer to him for 60 months for $150 per month. The lease payments would be due at the beginning of the month. Determine if Jim should lease or buy this trailer.

Explanation / Answer

Answer 26 Calculation of total cost of buy decision Year 0 1 2 3 4 5 NPV Purchase price of trailer -$8,500.00 Sales tax -$425.00 Tax savings $499.80 $799.68 $479.81 $287.88 $287.88 After tax salvage value $3,383.94 Net Cash flow -$8,925.00 $499.80 $799.68 $479.81 $287.88 $3,671.83 x Discount Factor @ 8% 1              0.92593           0.85734      0.79383      0.73503      0.68058 Present values -$8,925 $463 $686 $381 $212 $2,499 -$4,685 Total Cost of buy decision $4,685 Calculation of tax savings due to depreciation Year Cost of trailer Depreciation rate Depreciation Tax savings @ 28% 1 $8,925.00 20% $1,785.00 $499.80 2 $8,925.00 32% $2,856.00 $799.68 3 $8,925.00 19.20% $1,713.60 $479.81 4 $8,925.00 11.52% $1,028.16 $287.88 5 $8,925.00 11.52% $1,028.16 $287.88 $8,410.92 Calculation of after tax salvage value Salvage value of trailer $4,500.00 Less : Book value at the end of 5 th year $514.08 Gain on sale $3,985.92 Tax @ 28% on Gain $1,116.06 After tax salvage value of trailer (Salvage value - Tax) $3,383.94 Answer 27 Find out the present value of lease payments and compare it with the cost of buy option. We can use the present value of annuity due formula to calculate the present value of lease payments as payment will start at the beginning. Present value of annuity due = P + P * {[1 - (1+r)^-(n-1)]/r} Present value of annuity due = cost of lease option = ? P = lease payment = $150 r = rate of interest per month = 8%/12 = 0.0067 n = no.of months = 60 Present value of annuity = 150 + 150 * {[1 - (1+0.0067)^-(60-1)]/0.0067} Present value of annuity = 150 + 150 * 48.64722 Present value of annuity = 150 + 7297.08 = 7447.08 Cost of lease option = $7447 Cost of lease option is high compared to cost of buy option , hence Jim should buy this trailer.

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