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FISH & CHIPS INC, PART I
LEASE ANALYSIS Martha Millon,
If the computer is purchased, a maintenance contract must be obtained at a cost of $25,000, payable at the beginning of each year. After 4 years, the computer will be sold. Millon′s best estimate of its residual value at that time is $125,000. Because technology is changing rapidly however, the residual value is uncertain.
As an alternative. National Leasing is willing to write a 4-year lease on the computer, including maintenance, for payments of $340,000 at the beginning of each year. Fish 4c Chips′s marginal federal-plus-state tax rate is 40%. Help Millon conduct her analysis by answering the following questions.
a. 1. Why is leasing sometimes referred to as "off-balance-sheet" financing?
2. What is the difference between a capital lease and an operating lease?
3. What effect does leasing have on a firm′s capital structure?
b. 1. What is Fish & Chips's
2. Explain the rationale for the discount rate you used to find the PV.
c. 1. What is Fish & Chips′s present value cost of leasing the computer? (Hint: Again, construct a time line.)
2. What is the net advantage to leasing? Does your analysis indicate that the firm should buy or lease the computer? Explain.
d. Now assume that Millon believes that the computer′s residual value could be as low as $0 or as high as $250,000, but she stands by $125,000 as her expected value. She concludes that the residual value is riskier than the other cash flows in the analysis, and she wants to incorporate this differential risk into her analysis. Describe how this can be accomplished. What effect will it have on the lease decision?
e. Millon knows that her firm has been considering moving its headquarters to a new location, and she is concerned that these plans may come to fruition prior to the expiration of the lease. If the move occurs, the company would obtain new computers; hence, Millon would like to include a cancellation clause in the lease contract. What effect would a cancellation clause have on the risk of the lease?
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Chapter 20 Solutions
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EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT