Round Table Rental Yards provides construction equipment, trailers, crutches, et
ID: 2658374 • Letter: R
Question
Round Table Rental Yards provides construction equipment, trailers, crutches, etc., on short- term rentals. Historically, Art, the owner, has purchased the items that he rents out, but his business has been expanding so rapidly that he is considering both straight leases and lease- purchase arrangements. He has decided to use the procurement of a new bulldozer with a list price of $290,000 as a test case If he purchases the bulldozer outright, then he must also decide whether he should plan on overhauling it or selling it after 3 years. This overhaul will cost about $150,000, but it should double the useful life of the bulldozer. However, the bulldozer's value on the used market would drop from $180,000 after Year 3 to $135,000 after Year 6. Its annual operation and maintenance costs will start at $25,000 and increase by $7500 each year. This increase is due to increased use more than to increased age, so it is not affected by the overhaul purchases. In both cases, the subsidiary uses a term of 5 years with no option to extend it further. Art believes that other contract periods could be negotiated, but for this initial analysis he believes that their standard term is representative of the other possibilities. For the standard lease, the annual payment is $45.000. For the lease-purchase, the annual payment increases by $42,000. Although lease contracts can be written either way, for this lease Art would be responsible for the overhaul cost at Year 3 Art will insure the bulldozer for theft, catastrophic damage, and liability. This policy will cost him $9500 each year. He will spend about 5% of the rental income transporting it to and 69Explanation / Answer
Solution:
The financing plan which can be recommended under the given conditions is to make the annual payment lease of $45,000 which will increase after a period of time. Among the above two plans, it has been recommended to use the first financing plan. Apart from that, he will pay his regular expenses on the basis of the fixed expenses and rental income. He also needs to find out the present value of cost of $9,500 for five years which will come out to be $13,500. His expenses will increase over the time because of rise in cost of money. Considering the cost of bulldozer as well over the years, he will take into account the present value of the overhauling cost $150,000 but it will benefit also by doubling the overall age of the bulldozer. The present cost will be $168,000. On the other hand, he needs to decide upon the useful cost of investing into bulldozer. Therefore, by taking the charges over the lease would be much beneficial because in that he could earn the maximum interest on the amount which is yet to be paid. Also, the calculation of the final value of the bulldozer should be done according to the prices to be paid and the overall cost of the bulldozer.
The tax considerations will change the preference of financial planning because with 5 years MACRS, it will increase the costing with th additional taxation to be paid over the payment of the value of the bulldozer in instalments. It will increase the costing of the first plan by 41% of [(25,000) + (0.41 * 7,500 *6)] = $43,450. Therefore, under such conditions second plan would be quite successful.
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