Management in making the proper lease-versus-buy decision

Assignment Help Financial Management

Reference no: EM131813745

Lease versus Buy. Sadik Industries must install $1 million of new machinery in its Texas plant. It can obtain a bank loan for 100% pf the required amount. Alternatively, a Texas investment banking firm that represent a group of investors believes it can arrange for a lease financing plan. Assume that the following facts apply.

The equipment falls into the MACRS 3-year class.

Estimated maintenance expenses are $50,000 per year.

The firm’s tax rate is 34%.

If the money is borrowed, the bank loan will be at a rate of 14%. Amortized in six equal installments at the end of each year.

The tentative lease terms call for payments of $280,000 at the end of each year for 3 years. The lease is a guideline lease.

Under the proposed lease terms, the lessee must pay for insurance, property taxes, and maintenance.

Sadik must use the equipment if it is to continue in business, so it will almost certainly want to acquire the property at the end of the lease. If it does, then under the lease terms it can purchase the machinery at its fair market value at Year 3. The best estimate of this market value is $200,000, but it could be much higher or lower under certain circumstances. If purchased at Year 3, the used equipment would fall into the MACRS 3-year class. Sadik would actually be able to make the purchase on the last day of the year (i.e., slightly before Year 3), so Sadik would get to take the first depreciation expense at Year 3 (the remaining depreciation expenses would be at Year 4 through Year 6). On the time line, Sadik would show the cost of the used equipment at Year 3 and its depreciation expenses starting at Year 3.

To assist management in making the proper lease-versus-buy decision, you are asked to answer the following questions.

What is the net advantage of leasing? Should Sadik take the lease?

Consider the $200,000 estimated residual value. How high could the residual value get before the net advantage of leasing falls to zero?

The decision almost can e considered a bet on the future residual value. Do you think the residual cash flows are equal in risk to the other cash flows? If not, how might you address this issue? (Hint: if you discount a negative cash flow at a higher rate, you get a better NPV – the NPV of a negative cash flow stream is less negative at higher discount rates.) PLEASE SHOW ALL WORK.

Reference no: EM131813745

Questions Cloud

Determine the purpose of creating a digital hash : Determine the purpose of creating a digital hash. Explain in detail the need for this procedure and the potential damage if this critical step is not taken.

Determining problem on life insurance claims : Test whether the true proportion of all life insurance claims made to this company that are settled within 30 days is less than 85%.

Record the journal entries for the issuance of the bonds : The market rate at the date of issue is also 10%. For simplicity, use a 360-day year and 3 day months for all calculations

Compute the NPV of the computers : Compute the NPV of the computers. Use the nominal required rate of return and adjust the cash flows for inflation

Management in making the proper lease-versus-buy decision : To assist management in making the proper lease-versus-buy decision, How high could the residual value get before the net advantage of leasing falls to zero?

Asserting interest group of all smokers : A special interest group asserts that 90% of all smokers began smoking before age 18. In a sample of 850 smokers, 687 began smoking before age 18.

Discuss the demand schedule from the pizza poll : Combine the above supply schedule with the demand schedule from the pizza poll. Now suppose the government imposed a price ceiling

What entries are necessary to adjust the accounting records : Choice Two Manufacturing, which began operations in 2011, What entry(ies) are necessary to adjust the accounting records for the change in accounting principle

Write a paper to synthesize your ideas : Discuss whether or not your thinking about the topic has changed after playing the "Believing Game," even if your position on the issue has stayed the same.

User Account

All Pages