The Olsen Company has decided to acquire a new truck. One alternativeis to lease the truck on a 4-year contract for a lease payment of $10,000 per year, withpayments to be made at the beginning of each year. The lease would include maintenance.Alternatively, Olsen could purchase the truck outright for $40,000, financing with a bankloan for the net purchase price, amortized over a 4-year period at an interest rate of 10%per year, payments to be made at the end of each year. Under the borrow-to-purchasearrangement, Olsen would have to maintain the truck at a cost of $1,000 per year, payableat year-end. The truck falls into the MACRS 3-year class. The applicable MACRS depreciationrates are 33%, 45%, 15%, and 7%. The truck has a salvage value of $10,000, which is theexpected market value after 4 years, at which time Olsen plans to replace the truck regardlessof whether the firm leases the truck or purchases it. Olsen has a federal-plus-state taxrate of 40%.a. What is Olsen’s PV cost of leasing?b. What is Olsen’s PV cost of owning? Should the truck be leased or purchased?c. The appropriate discount rate for use in Olsen’s analysis is the firm’s after-tax cost ofdebt. Why?d. The salvage value is the least certain cash flow in the analysis. How might Olsenincorporate the higher risk of this cash flow into the analysis?
Mortgages
A mortgage is a formal agreement in which a bank or other financial institution lends cash at interest in return for assuming the title to the debtor's property, on the condition that the obligation is paid in full.
Mortgage
The term "mortgage" is a type of loan that a borrower takes to maintain his house or any form of assets and he agrees to return the amount in a particular period of time to the lender usually in a series of regular equally monthly, quarterly, or half-yearly payments.
The Olsen Company has decided to acquire a new truck. One alternative
is to lease the truck on a 4-year contract for a lease payment of $10,000 per year, with
payments to be made at the beginning of each year. The lease would include maintenance.
Alternatively, Olsen could purchase the truck outright for $40,000, financing with a bank
loan for the net purchase price, amortized over a 4-year period at an interest rate of 10%
per year, payments to be made at the end of each year. Under the borrow-to-purchase
arrangement, Olsen would have to maintain the truck at a cost of $1,000 per year, payable
at year-end. The truck falls into the MACRS 3-year class. The applicable MACRS depreciation
rates are 33%, 45%, 15%, and 7%. The truck has a salvage value of $10,000, which is the
expected market value after 4 years, at which time Olsen plans to replace the truck regardless
of whether the firm leases the truck or purchases it. Olsen has a federal-plus-state tax
rate of 40%.
a. What is Olsen’s PV cost of leasing?
b. What is Olsen’s PV cost of owning? Should the truck be leased or purchased?
c. The appropriate discount rate for use in Olsen’s analysis is the firm’s after-tax cost of
debt. Why?
d. The salvage value is the least certain cash flow in the analysis. How might Olsen
incorporate the higher risk of this cash flow into the analysis?
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