XYZ Inc. desires to evaluate two plans for acquiring equipment: borrowing to purchase and leasing. The firm is in the 40% tax bracket and it’s after tax cost of debt is 7.8%. The equipment costs $32,000 and will have a 5-year life. It will be depreciated under MACRS using a 5-year recovery period. The total purchase price will be financed by a 5-year, 13% loan requiring equal annual end-of-year payments of $9,098. The firm will pay $2,350 per year for a service contract that covers all maintenance costs; insurance and other costs will be borne by the firm. The firm plans to keep the equipment and use it beyond its 5-year recovery period. Alternatively, the firm can lease the equipment under a 5-year lease requiring annual end-of year payments of $7,750. All maintenance costs will be paid by the lessor, and insurance and other costs will be borne by the lessee. The lessee will exercise its option to purchase the asset for $2,200 at termination of the lease. For the purchasing plan, calculate the present value of the cash outflows For the leasing plan, calculate the present value of the cash outflows. Also determine which plan would be preferable.
XYZ Inc. desires to evaluate two plans for acquiring equipment: borrowing to purchase and leasing. The
firm is in the 40% tax bracket and it’s after tax cost of debt is 7.8%. The equipment costs $32,000 and will
have a 5-year life. It will be depreciated under MACRS using a 5-year recovery period. The total purchase
price will be financed by a 5-year, 13% loan requiring equal annual end-of-year payments of $9,098. The
firm will pay $2,350 per year for a service contract that covers all maintenance costs; insurance and other
costs will be borne by the firm. The firm plans to keep the equipment and use it beyond its 5-year recovery
period. Alternatively, the firm can lease the equipment under a 5-year lease requiring annual end-of year
payments of $7,750. All maintenance costs will be paid by the lessor, and insurance and other costs will be
borne by the lessee. The lessee will exercise its option to purchase the asset for $2,200 at termination of the
lease.
For the purchasing plan, calculate the
For the leasing plan, calculate the present value of the cash outflows. Also determine which plan would be
preferable.
Step by step
Solved in 2 steps with 6 images
