Question

A construction company is considering whether to lease or buy equipment for its new 4-year project. If they buy the equipment, it will have an initial investment cost of $640,000 with annual costs of $44,000. At the end of the 4 years the equipment can be sold for an estimated $384,000. For tax purposes, the company will use MACRS-ADS depreciation on the equipment. If they decide to lease, it will cost them $210,000 per year all inclusive. However, they will also be required to make a $125,000 initial deposit that will be refunded in full at the end of the 4-year lease. The refund is not taxable. The company's marginal effective tax rate is 25% and the capital gain tax rate is 15%. The after-tax MARR is 18% per year. Based on the after-tax cash flows, what would you recommend, leasing or purchase? Click the icon to view the partial listing of depreciable assets used in business Click the icon to view the interest and annuity table for discrete compounding when the MARR is 18% per year. Use the table to determine the ADS recovery period for construction equipment, and hence the depreciations, taxes and after-tax cash flows for each of the four years for the lease and purchase options. (Costs should be negative cash flows and revenues positive. Round to the nearest dollar.) Year ATCF (Lease) ATCF(Purchase) DD0000 ODDDDD Calculate the PW values for the two options. PW(Lease) (18%) = $ (Round to the nearest dollar.) PW(Purchase)(18%) = $ (Round to the nearest dollar.) Based on the PW values, which option is more economical? O A. Purchase O B. Leasing Click to select your answer(s) and then click Check Answer.

I am confused on how to find the ATCF's

Answer 1

Two options option Purchase option 2 locina- Leasing- pur.cort = 6,40,000 per year & i. = 44,000 Life of Equipment = lo years sale value after 4 year = 3,84,000 - Security Deposita 1,257000 Lease sent = $ 210,000/year For 4 years - Sewrity Deposit = $125.000 Tax rate = 25% Capital Gain Tax Rate = 15% after tax MARR = 18% Let us calculate Cash flows from both the options &

option & Purchasing the equipment year o Purchase cort - $ 6,40,000 Pirifactor = 1 Present value = $6,40,000 g Note & No tax deduction because the same is Capital Expenditure - 1 year 1-3 Annual cost after tax = 44,000x 75% = 33,00 Tax Saving on Dep = 16.40,000 x 25% = 16,000 1 Puri cost | 10 | [life Cloyes.) Net cost (cash flowe) . $ 17,000 tax Annual cost before + Depreciation Cost Less: tax @ 25% Less Add: Dep. (non Cash Exp.) Net cash flow - Pow. factor for 3 years = 44,000 - 64,000 11,08,000 on 27,000 81,000 64000 17,000 4690) 2. 1743 Total cost at present value (17,0008 2,690) 55234.70-36963.10

ng year 4 Donual cool after tax = 33,000 Less tax saving on Dep. = 16,000 Less: Net received from a Sate of Equipment Twet deceined - Cap. Gaina tax) = 3,26,400 (384000 - 384000 x 150%) (3.09.400) P. v. factor of 4th year 0.5158 P. v. of klet cash flow (1,59, 588.52) % Net cash flow from Puschasing the Equipment - 36963.10. = 6,40,000 + 4573170 - 1,59,588.52 $5.26 14348 517374.58.

was $ 1,25,000 option 2 : Leasing the Equipment- Year o Security Deposit = $ 1,25,000 P. V. Gactor 1 Piv. of Net cash flow = $1, 25. (Non tanable) - year 1-3 Lease sent = 2 10,000 f ood - Tax@ 25% = 52,500 Net cash flow - 1,57,500 p.v. factor of 211743 role Net cash flow at $3, 42, 452 125 present value 3 years - Year 4 210,000. 52,500 Lease sente a -Tax @ 25% = Refund of = Security Dep. (Non taxable.) 1,25,000 32,500 0.5158 Piv. factor of 4th year 32,500 3.16,763.50 & Net cash flow from Leasing the Equipment = 1,25,000 + 34245 2.23 + 16763.50 à 482, 2 15,75

Net cash flow option) option 2 15517374.58 $ 484,215.75 is option 2 (Leasing) is better due to less out flow in such option