Question

1. Your company plans to buy a new machine with a cost of $80,000. It is expected to operate for 12 years, with no salvage value at the end of that time. You have estimated that the purchase of this machine will enhance your company's net before-tax cash flow by $20,000 per year. The tax rate is 40%, and the company's after-tax minimum acceptable rate of return is 10% There are two financing options for the machine. The first would involve a $60,000 bank loan at an interest rate of 8%, payable over eight years. If you decide to use this option, the machine will be depreciated over 10 years using straight-line depreciation. Alternatively, you could lease the machine. That would require a deposit of $10,000, repayable at the end of the 12-year lease period. The rental payments would be $12,000 a year for 12 years, payable at the beginning of each year (but tax-deductible at the end of the tax year). Prepare a table showing the after-tax cash flow for debt financing, and one for leasing. What is the after-tax cost of the money "borrowed" by leasing? What would you recommend to your company's management? What other factors should your company consider in deciding whether to buy or lease the machine?

Answer 1

০ d lonn Repayment Can loov trstiatn Mear intemt ৯ o loe fore tax Ciareamatal) 4 2 2০০ 20000 4800 3UD 42ts 8000 20pu 2 go00 3 20,ao 3000 ০,০০ 210 2400 20,000 igoo touo 6 20, 000 3a00 gon 1200 2D,oun 600 20,09 20/000 ST 12000 20,000 000 Cach infiow After tax Present Vaur of tash Infto Col Cx GO%ot telono DiOunting Facror@ to7. 6,999 3 ০.৭০৭ 67 2.68 gquo 6'L09 9260 ০ ০। 5.75046 6 S4 5425.2 9670 5,114.34 g920 48.1 78 0.467 10 340 0.424 15260 O.326 16200 122,47.58 Pres ent Vaue Present Vaue of Cash Infiow yalue of cash ou for Present ,22,618.52-80000 42,67, 58

Leasing oftion PV Co bepbit nayable at the beginning 12.000 tess Release of Deposit ar the end of 12m C1260x 0.314) yeou PVCO 48172 Pvco PYCT Y Cash Infiow Rent Discountingfat eFAT i20u0 12000 1. 1200 3)176 20000 4260 6 495 120 00 1-11 H53 15312 0.314 12 2060 NPV PVCr-PVCo $44707.2- 6172 $ 36 535,2

As per the solutions attached herewith, the company should go for Debt financing in stead of leasing since, NPV is higher in case of Debt financing