8.2. Muirfield Corporation is planning to lease a machine for the next six years

Question

8.2. Muirfield Corporation is planning to lease a machine for the next six years for an annual lease payment of $1700 paid in advance, plus an initial fee of $500. There is a one-year delay for the tax benefits of lease payments and the initial fee. Muirfield may buy the machine, depreciate it fully over the next six years, and then sell it for 20% of the purchase price. Muirfield can borrow the money at 9% interest rate to finance the purchase, and its tax rate is 30%. Calculate the price of the machine, which will make purchasing or leasing to be equally costly.

ANSWER: $10,126.60; PLEASE SHOW SOLUTIONS

Explanation / Answer

Price of Machine at cost of purchasing or leasing of machine is equal = 6,525/0.65 = $ 10,038 (Different than your answer because of rounding off)

Present value of Lease Option Particulars Year 0 1 2 3 4 5 6 Initial Fees             -500 Annual Lease Payments          -1,700          -1,700          -1,700          -1,700          -1,700          -1,700 Tax Benefits of Lease Payments (1,700 * 0.3)               510               510               510               510               510               510 Net Cash Flows          -2,200          -1,190          -1,190          -1,190          -1,190          -1,190               510 Discount Factors @ 9%              1.00              0.92              0.84              0.77              0.71              0.65              0.60 Discounted Cash Flows (Net Cash Flows * Discounting Factors    -2,200.00    -1,091.74    -1,001.60       -918.90       -843.03       -773.42         304.10 Net Present Values of Cash Flows    -6,524.59 Let cost of Machine be $ x Present value of Machine Purchase Option Particulars Year 0 1 2 3 4 5 6 Cost of Machine -1.00 x Tax Benefits on Depreciation (x/6 * 0.3) 0.05 x 0.05 x 0.05 x 0.05 x 0.05 x 0.05 x Proceeds on sale of machine 0.20 x Net Cash Flows -1.00 x 0.05 x 0.05 x 0.05 x 0.05 x 0.05 x 0.25 x Discount Factors @ 9%              1.00              0.92              0.84              0.77              0.71              0.65              0.60 Discounted Cash Flows (Net Cash Flows * Discounting Factors -1.00 x 0.05 x 0.04 x 0.04 x 0.04 x 0.03 x 0.15 x Net Present Values of Cash Flows -0.65 x

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