Big Sky Mining Company must install $1.5 million of new machinery in its Nevada mine. It can obtain a bank loan for 100% of the purchase price, or it can lease the machinery. Assume that the following facts apply: The machinery falls into the MACRS 3-year class. Under either the lease or the purchase, Big Sky must pay for insurance, property taxes, and maintenance. The firm's tax rate is 40%. The loan would have an interest rate of 15%. The lease terms call for $400,000 payments at the end of each of the next 4 years. Assume that Big Sky Mining has no use for the machine beyond the expiration of the lease, the machine has an estimated residual value of $250,000 at the end of the 4th year. What is the NAL of the lease? Answer by competing the following worksheet template. (Please refer to the lecture notes). NPV LEASE ANALYSIS Year After-tax cash flows from leasing Lease payment Tax savings from lease Net cash flow PV cost of leasing at 9% <-- (1-40 %) *15% After-tax cash flows from buying the asset Payment of principal Interest Tax savings from interest Tax Savings from depreciation Sales Price Tax on gain/loss Net cash flow PV cost of owning at 9% <-- (1-40%) *15% NPV criterion: NAL=PV cost of leasing-PV cost of buying Decision?? MACRS rates 0 (Leasing) (Borrowing & Buying) Lease or Buy 1 33% 2 45% 3 15% 4 7%
Big Sky Mining Company must install $1.5 million of new machinery in its Nevada mine. It can obtain a bank loan for 100% of the purchase price, or it can lease the machinery. Assume that the following facts apply: The machinery falls into the MACRS 3-year class. Under either the lease or the purchase, Big Sky must pay for insurance, property taxes, and maintenance. The firm's tax rate is 40%. The loan would have an interest rate of 15%. The lease terms call for $400,000 payments at the end of each of the next 4 years. Assume that Big Sky Mining has no use for the machine beyond the expiration of the lease, the machine has an estimated residual value of $250,000 at the end of the 4th year. What is the NAL of the lease? Answer by competing the following worksheet template. (Please refer to the lecture notes). NPV LEASE ANALYSIS Year After-tax cash flows from leasing Lease payment Tax savings from lease Net cash flow PV cost of leasing at 9% <-- (1-40 %) *15% After-tax cash flows from buying the asset Payment of principal Interest Tax savings from interest Tax Savings from depreciation Sales Price Tax on gain/loss Net cash flow PV cost of owning at 9% <-- (1-40%) *15% NPV criterion: NAL=PV cost of leasing-PV cost of buying Decision?? MACRS rates 0 (Leasing) (Borrowing & Buying) Lease or Buy 1 33% 2 45% 3 15% 4 7%
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:### NAL (Net Advantage to Leasing) Calculation of Big Sky Mining Company
Big Sky Mining Company must install $1.5 million of new machinery in its Nevada mine. It can obtain a bank loan for 100% of the purchase price, or it can lease the machinery. Assume that the following facts apply:
1. The machinery falls into the MACRS 3-year class.
2. Under either the lease or the purchase, Big Sky must pay for insurance, property taxes, and maintenance.
3. The firm's tax rate is 40%.
4. The loan would have an interest rate of 15%.
5. The lease terms call for $400,000 payments at the end of each of the next 4 years.
6. Assume that Big Sky Mining has no use for the machine beyond the expiration of the lease, the machine has an estimated residual value of $250,000 at the end of the 4th year.
**Objective:** Calculate the NAL (Net Advantage to Leasing) by completing the following worksheet template and determine whether to lease or buy.
#### NPV Lease Analysis:
| Year | 0 | 1 | 2 | 3 | 4 |
|---------------------|------------|------------|------------|------------|------------|
| **After-tax cash flows from leasing** | | | | | |
| Lease payment | | (400,000) | (400,000) | (400,000) | (400,000) |
| Tax savings from lease| | 160,000 | 160,000 | 160,000 | 160,000 |
| Net cash flow | | (240,000) | (240,000) | (240,000) | (240,000) |
| PV cost of leasing at 9% <- (1-40%)*15% | | | | | |
| **After-tax cash flows from buying the asset** | | | | | |
| Payment of principal | (1,500,000)| | | | |
| Interest | | 225,000 | 175,500 | 120,084 | 59,217 |
| Tax savings from interest | | (90,000)
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