The S Company is considering the acquisition of a new processor used in its oper
ID: 2774240 • Letter: T
Question
The S Company is considering the acquisition of a new processor used in its operation. The processor has an installed cost of $55,000 and is expected to have a useful life of 5 years. If purchased, the firm would borrow the entire $55,000 at an interest rate of 6%. The processor would be depreciated over a 5 year ACRS life to a zero book value, but it is estimated that it could be sold for $6,000 after 5 years. A capital budgeting analysis indicates that purchase of the processor has a positive NPV Alternatively. S Company can lease the processor for the 5 year period for an annual lease payment of $12,000. If the processor is leased, annual operating expenses of $2,600 will be paid by the lessor. if the equipment is purchased, the firm will incur this expense. S Company's cost of capital is 12% and its marginal tax rate is 35%. If S Company borrows to purchase the processor, what is the annual loan payment? _ If S Company borrows to purchase the processor, the interest paid on the loan in year 2 is_ If S Company borrows to purchase the processor, total tax deductible expenses for year 3 are_ If S Company borrows to purchase the processor, the net cost of owning for year 3 is_ The present value of the costs of owning is_ The present value of the cost of leasing the processor is_Explanation / Answer
a) Annual Loan Payment = 55000/((1-(1+6%)^-5)/6%)
Annual Loan Payment = $ 13056.80
b) Principal Paid in 1st Year = 13056.80 - 55000*6%
Principal Paid in 1st Year = $ 9756.80
Amount outstantanding after 1 year = 55000-9756.80 = $ 45,243.20
Interest Paid in 2nd Year = 45,243.20*8%
Interest Paid in 2nd Year = $ 3619.46
c)
Tax Deductible Expenses in year 3 = Annual Operating Expenses + Depreciation + interest Expenses
Annual Operating Expenses = $ 2600
Depreciation = 19.20%*55000 = 10560
Interest Expenses = Amount outstantanding after 2 year * Interest Rate
Interest Expenses = (45243.20 + 3619.46 - 13056.80)*6%
Interest Expenses = 2148.35
Tax Deductible Expenses in year 3 = 2600+10560+2148.35
Tax Deductible Expenses in year 3 = $ 15308.35
d) Net cost of Owning year 3 = Annual Loan Payment + Annual Operating Expenses - Tax shield on Tax Deductible Expenses in year 3
Net cost of Owning year 3 = 13056.80 + 2600 - 35%*15308.35
Net cost of Owning year 3 = $ 10,298.88
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