Question

You work as a financial analyst at Steelcase Furniture Company. You are evaluating a potential lease agreement on a new machine. The new machine can be purchased on January 1 for $11,000 and can be depreciated over a 5-year period using the Straight Line Method. The machine an 8-year actual life and the salvage value at the end of the 8 years is $0. The operating expenses of the machine will be $600 per year. The lease calls for 8 annual payments of $2,100 per year with the first payment occurring immediately. (Assume the lease payments will occur at the beginning of each year and the tax benefits associated with the lease payment occurs at the end of the year) The interest rate on the company's debt is 9%. The weighted average cost of capital of the firm is 15%. The corporate tax rate is 30%

(Keep your answer to only two decimals)

A) What is the cost of owning? ____________

B) What is the cost of leasing? ____________

C) What is the Net Advantage to Leasing? _____________

D) What is the salvage value for you to be indifferent between lease and buying? _________________

Answer 1

		WACC rate is used as Discounting Rate
		Years ending	0	1	2	3	4	5	Total
		New Machine cost	11,000.00
		Depreciation		2,200.00	2,200.00	2,200.00	2,200.00	2,200.00
		Operating Expenses		600.00	600.00	600.00	600.00	600.00
		Tax Benefit		840.00	840.00	840.00	840.00	840.00
		Net Outflow	11,000.00	-240.00	-240.00	-240.00	-240.00	-240.00
		PVIF at 15%	1.00	0.8696	0.7561	0.6575	0.5718	0.4972
			11,000.00	-208.70	-181.47	-157.80	-137.22	-119.32	10,195.48
		Years starting	1	2	3	4	5	6	7	8	9	Total
		Lease cost	2,100.00	2,100.00	2,100.00	2,100.00	2,100.00	2,100.00	2,100.00	2,100.00
		Tax benefit		630.00	630.00	630.00	630.00	630.00	630.00	630.00	630.00
		Net Outflow	2,100.00	1,470.00	1,470.00	1,470.00	1,470.00	1,470.00	1,470.00	1,470.00	-630.00
		PVIF	1.00	0.87	0.76	0.66	0.57	0.50	0.43	0.38	0.33
			2,100.00	1,278.26	1,111.53	966.55	840.48	730.85	635.52	552.63	-205.95	8,009.87
a		What is the cost of owning			10,195.48
b		What is the cost of leasing			8,009.87
c	What is the Net Advantage to Leasing				2,185.61
d	What is the salvage value for you to be indifferent between lease and buying				F22/PVIF for 8th year at 15%
					6,685.88
		Debt rate is used as Discounting Rate
		Years ending	0	1	2	3	4	5	Total
		New Machine cost	11,000.00
		Depreciation		2,200.00	2,200.00	2,200.00	2,200.00	2,200.00
		Operating Expenses		600.00	600.00	600.00	600.00	600.00
		Tax Benefit		840.00	840.00	840.00	840.00	840.00
		Net Outflow	11,000.00	-240.00	-240.00	-240.00	-240.00	-240.00
		PVIF at 9%	1.00	0.9174	0.8417	0.7722	0.7084	0.6499
			11,000.00	-220.18	-202.00	-185.32	-170.02	-155.98	10,066.48
		Years starting	1	2	3	4	5	6	7	8	9	Total
		Lease cost	2,100.00	2,100.00	2,100.00	2,100.00	2,100.00	2,100.00	2,100.00	2,100.00
		Tax benefit		630.00	630.00	630.00	630.00	630.00	630.00	630.00	630.00
		Net Outflow	2,100.00	1,470.00	1,470.00	1,470.00	1,470.00	1,470.00	1,470.00	1,470.00	-630.00
		PVIF at 9%	1.00	0.9174	0.8417	0.7722	0.7084	0.6499	0.5963	0.5470	0.5019
			2,100.00	1,348.62	1,237.27	1,135.11	1,041.39	955.40	876.51	804.14	-316.18	9,182.26
a		What is the cost of owning			10,066.48
b		What is the cost of leasing			9,182.26
c	What is the Net Advantage to Leasing				884.22
d	What is the salvage value for you to be indifferent between lease and buying				F22/PVIF for 8th year at 9%
					1,761.86