Wolfson Corporation has decided to purchase a new machine that costs $4.9 millio

Question

Wolfson Corporation has decided to purchase a new machine that costs $4.9 million. The machine will be depreciated on a straight-line basis and will be worthless after four years. The corporate tax rate is 35 percent. The Sur Bank has offered Wolfson a four-year loan for $4.9 million. The repayment schedule is four yearly principal repayments of $1,225,000 and an interest charge of 6 percent on the outstanding balance of the loan at the beginning of each year. Both principal repayments and interest are due at the end of each year. Cal Leasing Corporation offers to lease the same machine to Wolfson. Lease payments of $1,375,000 per year are due at the beginning of each of the four years of the lease. a. What is the NAL of leasing for Wolfson? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) b. What is the maximum annual lease Wolfson would be willing to pay? Please show steps.

Explanation / Answer

a. NAL of Leasing :

Buy option :

Loan Repayment Schedule

Tax Savings

Present value of Net cash Outflow

Total PV of Net cash outflow = $ 3,339,536

Lease Option :

Total PV of lease payments = $ 3,378,375

Net advantage of Leasing = PV of Owning - PV of Leasing

= -$38,839

b. Maximum annual lease :

$3,339,536 = Annual lease payment x (1 + PVIFA(3.9%,3years))

Max Annual lease payment = $3,339,536 / 3.78

= $883,475

Maximum lease payment to be made at the beginning of the year = $ 883,475

Years 1 2 3 4 Principle $1,225,000 $1,225,000 $1,225,000 $1,225,000 Interest $294,000 $220,500 $147,000 $73,500 Payment per annum $1,519,000 $1,445,500 $1,372,000 $1,298,500

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