Question

Question 3: Unicon Labels needs to expand its facilities. To do so, the machine costing $200,000. The machine can be leased on lease and purchase plans are as follows:- s. 1o do so, the company must acquire a ne machine can be leased or purchased. The terms of the Lease: The leasing arrangement requires beginning arrangement requires beginning-of-year payments of $65,000 over 4 years. All other costs will be paid by the lessor. Lesse costs will be paid by the lessor. Lessee will exercise its option to purchase the asset for $20,000 at the termination of the lease contract. over furchase: If the company purchases the machine its cost of $800,000 will be financed • 10% loan requiring equal end-of-year payments. The machine will be curated under MACRS using a three-year recovery period, with annual rates provided below: Yol Yr2 Yr3 Yr4 Depreciation rates 33% 45% 15% 7% Unicon Labels will pay $10,000 per year for the service contract that covers all maintenance cost. Insurance premium of $3,000 per year is required to be paid in advance. The company plans to keep the machine and use it beyond its 5-year recovery period. Unicon's tax rate is 30% Which alternative - lease or purchase - would you recommend? [Total: 20 marks]

Answer 1

If Purchase option exercised, then total cash outflow: |Total Amount in loan Repaid(Prinicipal and Interest) Less: Tax Benefit of Depreciation Add: total Maintenance Cost(10000*3) Add: Total Insurance Exp(3000*3) 252376.6 60000 30000 9000 Total Cash Outflow 231376.6 If Lease Option Exercised, then total Cash Outflow Lease Amount(65000*4) 260000 As we can cash outflow is more in lease option, so Purchase option should be excercised.

Asset Cost Recovery Depreciat Tax Rate Tax Benefit Year 200000 33% 30% 66000 19800 45% 30% 200000 90000 27000 15% 30% 3 200000 30000 9000 30% 7% 14000 4200 4 200000 Total Tax Benefit 60000 S 200,000.00 Loan with Annual Payments 10% Interest Rate Compounded Annually 4 Years Payment Principal Paid Interest Paid ·Remaining Balance S 20,000.00 S 15,690.58 S 10,950.23 S 5,735.83 Year $ 63,094.16 $ 63,094.16 $ 63,094.16 $ 63,094.16 $ 43,094.16 $ 47,403.58 $ 52,143.93 S 57,358.33 $ 156,905.84 $ 109,502.26 $ 57,358.33 2020 2021 2022 2023 $.0 S 200,000.00 S 52,376.64 Totals $ 252,376.64