Question

Warf Computers has decided to proceed with the manufacture and distribution of the virtual keyboard (VK) the company has developed. To undertake this venture, the company needs to obtain equipment for the production of the microphone for the keyboard. Because of the required sensitivity of the microphone and its small size, the company needs specialized equipment for production.

Nick Warf, the company president, has found a vendor for the equipment. Clapton Acoustical Equipment has offered to sell Warf Computers the necessary equipment at a price of $6.1 million. Because of the rapid development of new technology, the equipment falls in the three-year MACRS depreciation class. At the end of four years, the market value of the equipment is expected to be $780,000.

Alternatively, the company can lease the equipment from Hendrix Leasing. The lease contract calls for four annual payments of $1.48 million due at the beginning of the year. Additionally, Warf Computers must make a security deposit of $400,000 that will be returned when the lease expires. Warf Computers can issue bonds with a yield of 11 percent, and the company has a marginal tax rate of 21 percent.

Should Warf buy or lease the equipment?

Answer 1

Warf should lease the equipment sincei t has higher NPV

	Buy Option
Year	Initial cost	Tax shield= Tax rate*MACRS rate*Cost	Salvage after tax	Net CF
0	-6100000			-6100000
1		426957.30		426957.30
2		569404.50		569404.50
3		189716.10		189716.10
4		94922.10	616200	711122.10
			NPV	(4,646,055.39)

Lease
Year	Deposit	Lease payment after tax	Net CF
0	-400000	-1169200	-1569200
1		-1169200	-1169200
2		-1169200	-1169200
3		-1169200	-1169200
4	400000		400000
		NPV	(4,162,898.86)

AutoSave © of HO- Book1 - Excel Sign in Paste File Home Insert Draw Page Layout Formulas Data Review View Help O Tell me what you want to do Share co Insert - A Calibri 11 - A À = = = din ake General Delete - T ZY U BI U - - - A - E 3- $ - % 9 OSOS Conditional Format as Cell Sort & Find & Format Formatting Table Styles Filter - Select Clipboard Font Alignment to Number Styles Cells Editing C3 : * for Tax shield= A B C F G H Buy Option Lease Year Initial cost Tax shield= Salvage after tax Net CF Year Deposit Lease payment after tax Net CF Tax rate* MACRS rate*Cost 3 4 0 -6100000 =SUM(B4:04) 0 -400000 =-1480000*(1-21%) =SUM(H4:14) 5 1 =21%*33.33%*6100000 =SUM(B5:05) =-1480000*(1-21%) =SUM(H5:15) 6 2 =21%*44.45%*6100000 =SUM(B6:06) =-1480000*(1-21%) =SUM(H6:16) 7 =21%*14.81%*6100000 =SUM(B7:07) =-1480000*(1-21%) =SUM(H7:17) =21%*7.41%*6100000 =780000*(1-21%) =SUM(B8:08) 400000 =SUM(H8:18) 2 in 4 NPV =NPV(11%,E5:E8)+E4 NPV =NPV(11%,J5:58)+J4 12 13 14