Suppose Procter and Gamble (P&G;) is considering purchasing $19 milion in new ma

Question

Suppose Procter and Gamble (P&G;) is considering purchasing $19 milion in new manufacturing equipment. If it purchases the equipment, it will depreciate it on a straight-line basis overthe five years, after which the equipment will be worthless. It will also be responsible for maintenance expenses of $1.00 million per year Alternatively, it can lease the equipment for $4.2 million per year for the five years, in which case the lessor will provide necessary maintenance. Assume P&G;?s tax rate is 40% and its borrowing cost is 6.0% a. What is the NPV associated with leasing the equipment versus financing it with the lease equivalent loan? 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 financing a purchase?

Explanation / Answer

Hello

Assuming that lease payments are due at the beginning of the year,

To compute a NPV associated with leasing anf financing with lease equivalent loan...., with after tax borrowing cost = 6*(.6) = 3.6

Company must choose to lease the asset as it will save $3,103,662.

(b) Break-even lease rate is $5,308,995

Using Excel's Goal seek feature, i.e. Data -> What-if-Analysis -> Goal Seek.

Before Tax Lease Payments to get NPV=0 is $3185397.

Hence after tax lease amount is 3185397/0.6 = $5,308,995

I hope this clears your doubt.

Feel free to comment if you still have any doubt.

Do give a thumbs up if you find this helpful.

Purchase Option Purchase Price 19000000 Time 0 Time 1 Time 2 Time 3 Time 4 Time 5 Purchase Price (19000000) Savings of Tax on Depreciation 1520000 1520000 1520000 1520000 1520000 Maintenance Exp(Net of Tax Savings) (600000) (600000) (600000) (600000) (600000) Total Cash Flows (19000000) 920000 920000 920000 920000 920000

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

---

---

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