Question

Investment decision - Lessor's evaluation 2. Wilayah Leasing & Credit Berhad is arranging for a 6-year lease financing facility for a new boiler costing $5,000,000. Assume the following information: • Equipment falls under the MACRS 5-year class An estimated annual maintenance expense of $150,000 is paid at the end of each year and this cost is expected to increase at a rate of 5% annually from year 4 onwards. Annual insurance premium is calculated at a rate of 1.65% of the insured value. For the first year, the equipment will be insured for $5.0 million. For the subsequent years, the book value of the asset is taken as the yearly insured value. Annual insurance premium are being paid at the beginning of the year. Under the proposed lease terms, the lessor must pay for maintenance and insurance The tentative lease payment calls for a six beginning-of-the-year payments of $650,000 Corporate tax is at 35% Wilayah Leasing will invest 75% of its fund to purchase the equipment and finance the remaining cost with a bank loan of 6.75% nominal rate, on yearly rests, payable in 6 years ordinary annuity) . At the end of the lease period, the equipment can be sold for $500,000. Should Wilayah Leasing proceed with this arrangement to finance its customer?

Answer 1

purchase value=		$    5,000,000.00
residual value =		$       500,000.00
considering linear depreciation model				depreciaton each year =			750000
Wilayah	is lessor
			2019	2020	2021	2022	2023	2024	2025
	purchase	$ (5,000,000.00)
	lease payments		$      650,000.00	$      650,000.00	$      650,000.00	$      650,000.00	$      650,000.00	$      650,000.00
	maintenance		$   (150,000.00)	$   (150,000.00)	$   (150,000.00)	$   (157,500.00)	$   (165,375.00)	$   (173,643.75)
	insurance		$      (82,500.00)	$      (70,125.00)	$      (57,750.00)	$      (45,375.00)	$      (33,000.00)	$      (20,625.00)
	interest payment		$      (84,375.00)	$      (84,375.00)	$      (84,375.00)	$      (84,375.00)	$      (84,375.00)	$      (84,375.00)
			$      333,125.00	$      345,500.00	$      357,875.00	$      362,750.00	$      367,250.00	$      371,356.25
	depreciation		$      750,000.00	$      750,000.00	$      750,000.00	$      750,000.00	$      750,000.00	$      750,000.00
	book value		$ 5,000,000.00	$ 4,250,000.00	$ 3,500,000.00	$ 2,750,000.00	$ 2,000,000.00	$ 1,250,000.00	$    500,000.00

comapny will not have to pay tax as depreciation is more than lease payment received. so value is negative.

So company should lease the item as it will benefit them as cash flow is positive.