Question

Suppose Procter and Gamble​ (P&G) is considering purchasing $20 million in new manufacturing equipment. If it purchases the​ equipment, it will depreciate it on a​ straight-line basis over the five​ years, after which the equipment will be worthless. It will also be responsible for maintenance expenses of $1.25 million per year.​ Alternatively, it can lease the equipment for  $4.6 million per year for the five​ years, in which case the lessor will provide necessary maintenance. Assume​ P&G?s tax rate is 30% and its borrowing cost is 7.0%.

a. What is the NPV associated with leasing the equipment versus financing it with the lease equivalent​ loan?

The NPV is $_____million.  ​(Round to two decimal​ places.)

Under these​ assumptions, leasing is (less or more) attractive than financing a purchase of the equipment.

b. What is the​ break-even lease rate —that is, what lease amount could​ P&G pay each year and be indifferent between leasing and financing a​ purchase?

The​ break-even lease rate is $_____million.  ​(Round to two decimal​ places.)

Answer 1

a. The NPV is $-18,667,435.83 under Purchase option.

The NPV is $-13,202,624 under Leasing option.

Under these​ assumptions, leasing is more attractive than financing a purchase of the equipment.

b. The​ break-even lease rate is $6,504,019.84

Purchase LLLLL Particulars : $ 2,00,00,000.00 - Initial Cost 1/5 -- Year in) Initial Cost Depreciation Maintenance Total Expenses Tax benefits Depreciation Cash Flows 30% of Total Expenses S-40,00,000.00 $ -12,50,000.00 S-52.50,000.00 5 15,75,000.00 S 40,00,000.00 S 3,25,000.00 S-40,00,000.00 S-40,00,000.00 $ -12,50,000.00 S-12,50,000.00 $ -52,50,000.00 $-52,50,000.00 S 15,75,000.00 $ 15,75,000.00 $ 40,00,000.00 $ 40,00,000.00 $ 3,25,000.00 $ 3,25,000.00 $-40,00,000.00 S-12,50,000.00 $-52.50,000.00 S 15,75,000.00 $ 40,00,000.00 5 3,25,000.00 $ 40,00,000.00 5-12,50,000.00 $-52.50,000.00 $ 15,75,000.00 $ 40,00,000.00 S 3,25,000.00 S-2,00,00,000.00 NPV -Cash Flow /(1+i) n 5 s S-2,00,00,000.00 S 3,03,738.32 $ 2,83,86759 zoom S 2,65,296.81 $ 2,47,940 94 $ 2,31,720.51 S 1.86.67.435.83 Leasing Particulars Year (n) Leases Tax benefits Cash Flows. 30% of Total Expenses $-46,00,000.00 $ 13,80,000.00 $ 32,19,999.00 $ -46,00,000.00 S 13,80,000.00 S-32,19,998.00 $ -46,00,000.00 $ 13,80,000.00 $ -32,19.997.00 $ -46,00,000.00 $ 13,80,000.00 $ 32,19,996.00 $ -46,00,000.00 5 13,80,000.00 $ -32.19,995.00 5 =Cash Flow / 11 +i)n S-30,09,344.86 $-28,12,470.96 $-26,28,476.71 $ 24,56,519,53 S-22,95,811.93 $ -1,32.02.624.00 PV of Leases ( NPV under Purchase) S 1,86,67,435.83 Cash Flows fleases) Rate of Interest number of years (1+i)-n) /i] - 100/70 C- S 65,04,019.84 =D24/([1-1+D26) -0271/026) * (100/70)