Question

To finance some manufacturing tools it needs for the next 3 years, Waldrop Corporation is considering a leasing arrangement. The tools are estimated to have a value of 10% of their original cost after 3 years. The firm will depreciate the cost of the tools on a straight-line basis over their 3-year life. The purchase price of the tools is $4,800,000 or the firm can make 3 equal end-of-year lease payments of $2,100,000 each and lease them. The firm's tax rate is 40%. Annual maintenance costs associated with ownership are estimated at $240,000, but this cost would be borne by the lessor if it leases. What is the net advantage to leasing (NAL).

Answer 1

Years Cost of the tool Lease pay Salavage value (10% of the cost Annual maintenance costs Tax sa 3 $ 4,800,000 S2100,000 480,000 nts 240,000 96.000 on maintenance costs 240.000 * 40% Straight line method of depreciation is used Depreciation 4.800,000 480,000 3 Tax Rate Tax saving from depreciation $ 1,440,000 ar 40% 576,000 1.440.000 * 40% Cost of buying the tool 3 $ 96,000 $ 96,00096,000 $ 576,000 $ 576,000$ 576,000 $ 480,000 $ (240,000 $ (240,000 (240,000 Tax saving on Maintenance cost Tax saving from depreciation Salavge Value of Tool Maintenance cost Cash purchase Total Net effect of cash purchases $ (4,800,000 $ (4,800,000)$ 432,000$432,000 912,000 $(3,024,000) Cost of leasing the tool 3 Lease pay Tax savings from lease Total Net effect of leasing $ (2,100,000)$ (2,100,000)$ (2,100,000 $ 840,000$ 840,000$ 840,000 $ (1,260,000) $ (1,260,000) (1,260,000 $(3,780,000) NAL Cost of owning - Cost of lease (6,804,000)