Kohers Inc is considering a leasing arrangement to finance some manufacturing to
ID: 2665560 • Letter: K
Question
Kohers Inc is considering a leasing arrangement to finance some manufacturing tools that it needs for the next 3 years. The tools will be obsolete and worthless after 3 years. The firm will depreciate the cost of the tools on a straight-line basis over their 3 year life. It can borrow $4,800,000, the purchase price, at 10% and buy the tools, or it can make 3 equal end-of-year lease payments of $2,100,000 each and lease them. The loan obtained from the bank is a 3-year simple interest loan, with interest paid at the end of the year. The firm's tax rate is 40%. Annual maintenance costs associated with ownership are estimated at $240,000 but this cost would be borne by the lessor if it leases. What is the net advantage to leasing(NAL), in thousands?(Suggestion:Delete 3 zeros from dollars and work in thousands)
Explanation / Answer
present cost if purchased
= purchase cost + PV of(- tax saved on depreciation + interest cost after Tax + maintenance cost) for 3 years at assumed 10% discount interest rate.
= 4800+((-4800/3 *0.40)+ 4800*0.10*(1-0.4) + 240))*(1.10^3-1)/(0.10*1.10^3)
= 4521.47 (k$)
present cost if leased
= (2100 + interest to bank @ assumed 10% *(1-0.4))*(1.10^3-1)/(0.10*1.10^3)^3
= (2100 + 210 *(1-0.4))*(1.10^3-1)/(0.10*1.10^3)
= 5535.73 (k$)
net advantage to leasing = 4521.47 - 5531.73 = - 1010.26 (k$) (loss compared to purchase option) (ANSWER)
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