Question

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Lease or Buy Wolfson Corporation has decided to purchase a new machine that costs $3.2 million. The machine will be depreciated on a straight-line basis and will be worthless after four years. The corporate tax rate is 35 percent. The Sur Bank has offered Wolfson a four-year loan for $3.2 million. The repayment schedule is four yearly principal repayments of $800,000 and an interest charge of 9 percent on the outstanding balance of the loan at the beginning of each year. Both principal repayments and interest are due at the end of each year. Cal Leasing Corporation offers to lease the same machine to Wolfson. Lease payments of $950,000 per year are due at the beginning of each of the four years of the lease. 14. a. Should Wolfson lease the machine or buy it with bank financing? b. What is the annual lease payment that will make Wolfson indifferent to whether it leases the machine or purchases it? www.mheduc

Answer 1

soln:

a) From the image you can see that if Wolfson buys the machine, then the net cost for the machine is coming out to be 2,800,000, whereas if he leases the machine then he will have to pay (950,000 * 4) = 3,800,000.

Sears Tox Sowed due Principal Paument Cintarest at Principal Interest paid 360 1) (298,00 + 300,600) = 1,088,600 7') on 3,2M = 299,000 to deprecia hem Depressalon will be gooo amely as 15 Strareht de with Zeno Sal tage van So tax Saved will (Tax Rate Dep) = 0.35 * 2,69,90 280,000 ql on 13.2-08) = 216,500 Bogaso 280,000 Flom (2.4-08) = 144,000 309,000 29050 2) (9161 (216,099 +300,00) = 1,016,000 (144,000 4300,005) = 944,000 Lou 800,999 299,000 olon (1.6-0.8) -72,000 77 2,003 +809,656) =872,050 4 Payment so ię we calculate the actual expense year on year, that is the payment made and tax saved, then we will get the net expense Tax Saved Net Expense 1,088,000 280,000 (1,038,040 go$,000 1,016,000 230,000 296,090 944,600 280,000 664,000 872,000 280,000 Year 572,600 a mo Total 2,800,000

b) The annual Lease should be 2,800,000 / 4 = 700,000. Then wolfson should be indifferent to whether he should lease or buy it.