Question

Smith company is conducting a lease analysis on some assembly line equipment that it will procure in the coming year. The following data have been developed.

• Smith plans to acquire an automated assembly line with a 10-year life and a cost of $10 million, delivered and installed. However, Smith plans to use the equipment for only 5 years, for it will discontinue the product line at that time. • Smith can borrow the required $10 million at an after-tax cost of 10%.

• The equipment’s estimated salvage value is $50,000 after 10 years of use, but it is $1,000,000 after only 5 years of use.

• Smith can lease the equipment for 5 years at a rental charge of $2,750,000, payable at the beginning of each year, but the lessor will own the equipment upon the expiration of the lease.

• Depreciation rate is 0.2, 0.32, 0.19, 0.12 and 0.11 in years 1 through 5, respectively. • Smith’s corporate tax rate is 40%. Should Smith lease or borrow and buy the equipment?

Borrowing and buying (price in thousand $)
	Year	0	1	2	3	4	5
1	purchase price	-10,000
2	dep tax savings		800	1,280	760	480	440
3	Salvage						1,000
4	Tax payable on sale						-160
5	Net cash flows	-10,000	800	1,280	760	480	1280
	Cost of debt	0.10
	PV	-10,000	727	1,058	571	328	795
	NPV of borrow to buy	-$6,521.25

in this answer, i want to now how to caclulate the salvage is 1000 and

why the purchase price is -10000