Company B is considering buying a new machine that has an estimated installation

Question

Company B is considering buying a new machine that has an estimated installation cost of $57,000. The machine has an expected life of 5 years and will be depreciated over a 5 year ACRS life to a zero salvage value. It is expected that the machine can be sold at that time for $6,000. If purchased, the entire $57,000 would be borrowed at an interest rate of 9%. A capital budgeting analysis results in a positive NPV for the project. An alternative to purchase is to lease the asset for an annual lease payment of $13,500. The lease includes maintenance services estimated to cost Company C $3,000 per year if they were not included in the lease payment. Company C

Explanation / Answer

Discounting rate Year 9 0 1.00 1 0.92 2 0.84 3 0.77 4 0.71 5 0.65 3.89 Equidated monthly installment = loan amount / sum of discounting factors@9% for 5 yrs = 57000 / 3.89 14652.96 Loan repayment schedule year Lease liability installment amount Finance charge @ 9% principal amt reduced Post tax interest 0 57000 0 1 57000 14653 5130.00 9523.00 3385.80 2 47477.00 14653 4272.93 10380.07 2820.13 3 37096.93 14653 3338.72 11314.28 2203.56 4 25782.65 14653 2320.44 12332.56 1531.49 5 13450.09 14653 1210.51 13450.09 798.94 0.00 Depreciation schedule cost of asset 57000 year macr depre rate tax savings on depre WDV of asset 0 cost 57000 1 20.00% 11400.00 3876.00 Less : depreciation -53716.80 2 32.00% 18240.00 6201.60 WDV 3283.20 3 19.20% 10944.00 3720.96 Less: salvage -6000 4 11.52% 6566.40 2232.58 Profit 2716.80 5 11.52% 6566.40 2232.58 tax @ 0.34 923.712 53716.80 18263.71 Post tax salvage value 5076.288 Option 1 - buy the asset Year 0 1 2 3 4 5 tax savings on depre -3876.00 -6201.60 -3720.96 -2232.58 -2232.58 post tax interest 3385.80 2820.13 2203.56 1531.49 798.94 Principal outflow 9523.00 10380.07 11314.28 12332.56 13450.09 asset purchase -57000.00 Loan inflow 57000.00 salvage value -5076.29 Total cash flow 0.00 9032.80 6998.60 9796.87 11631.47 6940.16 Discounting rate 11 1.00 0.90 0.81 0.73 0.66 0.59 present value of cash flow 0.00 8137.66 5680.22 7163.39 7662.01 4118.65 Net present value of outflow 32761.93 Option 2 - lease the asset Year 0 1 2 3 4 5 Post tax lease rental 8910 8910 8910 8910 8910 maintenance cost saved post tax -1980 -1980 -1980 -1980 -1980 total cash flow 6930 6930 6930 6930 6930 Discounting rate 11 1.00 0.90 0.81 0.73 0.66 0.59 present value of cash flow 6243.24 5624.54 5067.16 4565.01 4112.62 Net present value of outflow 25612.57 The lease option is preferable as the outflow is lesser in that case

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.