LEASE VERSUS BUY Sullivan-Swift Mining Company must install $1.2 million of new machinery in its Nevada mine. It can obtain a bank loan for 100% of the required amount. Alternatively, a Nevada investment banking firm that represents a group of investors believes that it can arrange for a lease financing plan. Assume that the following facts apply: 1. The equipment falls in the MACRS 3-year class. The applicable MACRS rates are 33%, 45%, 15%, and 7%. 2. Estimated maintenance expenses are $80,000 per year. 3. Sullivan-Swift's federal-plus-state tax rate is 45%. 4. If the money is borrowed, the bank loan will be at a rate of 13%, amortized in 4 equal installments to be paid at the end of each year. 5. The tentative lease terms call for end-of-year payments of $300,000 per year for 4 years. 6. Under the proposed lease terms, the lessee must pay for insurance, property taxes, and maintenance. 7. The equipment has an estimated salvage value of $300,000, which is the expected market value after 4 years, at which time Sullivan-Swift plans to replace the equip- ment regardless of whether the firm leases or purchases it. The best estimate for the salvage value is $300,000, but it may be much higher or lower under certain circumstances. To assist management in making the proper lease-versus-buy decision, you are asked to answer the following questions. a. Assuming that the lease can be arranged, should Sullivan-Swift lease or borrow and buy the equipment? Explain. b. Consider the $300,000 estimated salvage value. Is it appropriate to discount it at the same rate as the other cash flows? What about the other cash flows-are they all equally risky? Explain.
LEASE VERSUS BUY Sullivan-Swift Mining Company must install $1.2 million of new machinery in its Nevada mine. It can obtain a bank loan for 100% of the required amount. Alternatively, a Nevada investment banking firm that represents a group of investors believes that it can arrange for a lease financing plan. Assume that the following facts apply: 1. The equipment falls in the MACRS 3-year class. The applicable MACRS rates are 33%, 45%, 15%, and 7%. 2. Estimated maintenance expenses are $80,000 per year. 3. Sullivan-Swift's federal-plus-state tax rate is 45%. 4. If the money is borrowed, the bank loan will be at a rate of 13%, amortized in 4 equal installments to be paid at the end of each year. 5. The tentative lease terms call for end-of-year payments of $300,000 per year for 4 years. 6. Under the proposed lease terms, the lessee must pay for insurance, property taxes, and maintenance. 7. The equipment has an estimated salvage value of $300,000, which is the expected market value after 4 years, at which time Sullivan-Swift plans to replace the equip- ment regardless of whether the firm leases or purchases it. The best estimate for the salvage value is $300,000, but it may be much higher or lower under certain circumstances. To assist management in making the proper lease-versus-buy decision, you are asked to answer the following questions. a. Assuming that the lease can be arranged, should Sullivan-Swift lease or borrow and buy the equipment? Explain. b. Consider the $300,000 estimated salvage value. Is it appropriate to discount it at the same rate as the other cash flows? What about the other cash flows-are they all equally risky? Explain.
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
Related questions
Question
Lease versus buy
Transcribed Image Text:20-5 LEASE VERSUS BUY Sullivan-Swift Mining Company must install $1.2 million of new
machinery in its Nevada mine. It can obtain a bank loan for 100% of the required amount.
Alternatively, a Nevada investment banking firm that represents a group of investors
believes that it can arrange for a lease financing plan. Assume that the following facts
apply:
1. The equipment falls in the MACRS 3-year class. The applicable MACRS rates are 33%,
45%, 15%, and 7%.
2. Estimated maintenance expenses are $80,000 per year.
3. Sullivan-Swift's federal-plus-state tax rate is 45%.
4. If the money is borrowed, the bank loan will be at a rate of 13%, amortized in 4 equal
installments to be paid at the end of each year.
5. The tentative lease terms call for end-of-year payments of $300,000 per year for
4 years.
6. Under the proposed lease terms, the lessee must pay for insurance, property taxes, and
maintenance.
7. The equipment has an estimated salvage value of $300,000, which is the expected
market value after 4 years, at which time Sullivan-Swift plans to replace the equip-
ment regardless of whether the firm leases or purchases it. The best estimate for
the salvage value is $300,000, but it may be much higher or lower under certain
circumstances.
To assist management in making the proper lease-versus-buy decision, you are asked to
answer the following questions.
a. Assuming that the lease can be arranged, should Sullivan-Swift lease or borrow and
buy the equipment? Explain.
b. Consider the $300,000 estimated salvage value. Is it appropriate to discount it at the
same rate as the other cash flows? What about the other cash flows-are they all
equally risky? Explain.
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
This is a popular solution!
Trending now
This is a popular solution!
Step by step
Solved in 3 steps with 5 images
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, accounting and related others by exploring similar questions and additional content below.Recommended textbooks for you
Accounting
Accounting
ISBN:
9781337272094
Author:
WARREN, Carl S., Reeve, James M., Duchac, Jonathan E.
Publisher:
Cengage Learning,
Accounting Information Systems
Accounting
ISBN:
9781337619202
Author:
Hall, James A.
Publisher:
Cengage Learning,
Accounting
Accounting
ISBN:
9781337272094
Author:
WARREN, Carl S., Reeve, James M., Duchac, Jonathan E.
Publisher:
Cengage Learning,
Accounting Information Systems
Accounting
ISBN:
9781337619202
Author:
Hall, James A.
Publisher:
Cengage Learning,
Horngren's Cost Accounting: A Managerial Emphasis…
Accounting
ISBN:
9780134475585
Author:
Srikant M. Datar, Madhav V. Rajan
Publisher:
PEARSON
Intermediate Accounting
Accounting
ISBN:
9781259722660
Author:
J. David Spiceland, Mark W. Nelson, Wayne M Thomas
Publisher:
McGraw-Hill Education
Financial and Managerial Accounting
Accounting
ISBN:
9781259726705
Author:
John J Wild, Ken W. Shaw, Barbara Chiappetta Fundamental Accounting Principles
Publisher:
McGraw-Hill Education