High electricity costs have made Farmer Corporation’s chicken-plucking machine e

Question

High electricity costs have made Farmer Corporation’s chicken-plucking machine economically worthless. Only two machines are available to replace it. The International Plucking Machine (IPM) model is available only on a lease basis. The lease payments will be $74,000 for five years, due at the beginning of each year. This machine will save Farmer $24,000 per year through reductions in electricity costs. As an alternative, Farmer can purchase a more energy-efficient machine from Basic Machine Corporation (BMC) for $375,000. This machine will save $34,000 per year in electricity costs. A local bank has offered to finance the machine with a $375,000 loan. The interest rate on the loan will be 8 percent on the remaining balance and will require five annual principal payments of $75,000. Farmer has a target debt-to-asset ratio of 65 percent. Farmer is in the 35 percent tax bracket. After five years, both machines will be worthless. The machines will be depreciated on a straight-line basis.

How much debt is displaced by this lease? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

(pls show work)

High electricity costs have made Farmer Corporation’s chicken-plucking machine economically worthless. Only two machines are available to replace it. The International Plucking Machine (IPM) model is available only on a lease basis. The lease payments will be $74,000 for five years, due at the beginning of each year. This machine will save Farmer $24,000 per year through reductions in electricity costs. As an alternative, Farmer can purchase a more energy-efficient machine from Basic Machine Corporation (BMC) for $375,000. This machine will save $34,000 per year in electricity costs. A local bank has offered to finance the machine with a $375,000 loan. The interest rate on the loan will be 8 percent on the remaining balance and will require five annual principal payments of $75,000. Farmer has a target debt-to-asset ratio of 65 percent. Farmer is in the 35 percent tax bracket. After five years, both machines will be worthless. The machines will be depreciated on a straight-line basis.

Explanation / Answer

Calculation of Lease Value Year Cash Flow PVAF8% Amount 0 ($74,000) $1.00000 -74000 1 $24,000 $0.92590 22221.6 2 $24,000 $0.85730 20575.2 3 $24,000 $0.79380 19051.2 4 $24,000 $0.73500 17640 5 $24,000 $0.68060 16334.4 21822.4

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