Reference no: EM131558822
SHOW CALCULATIONS ANSWER ALL PARTS
Fresh Farming Company is negotiating a lease for five new tractors with Leasing International. The terms of the lease offered by Leasing International call for a total payment of $205,000 at the beginning of each year of a 5-year lease.
As an alternative to leasing, Fresh Framing can borrow from a local bank and buy the tractors. Fresh Farming has received its best offer for buying the tractors from Trucks, Inc. for a total price of $1 million. The $1 million would be borrowed on a simple interest term loan at a 10 percent interest rate for 5 years.
The tractors fall into the MACRS 5-year class and have a total expected residual value of $100,000. The depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52% and 5.76%, for Years 1 to 6, respectively. Maintenance costs would be included in the lease payments. If the tractors were owned, a maintenance contract would be purchased at the beginning of each year for a total of $10,000 per year.
In any case, Fresh Farming plans to buy a new fleet of tractors at the end of the fifth year. Leasing International has a 40% federal-plus-state marginal tax rate, while Fresh Farming has a total tax rate of 20%.
a. What would be Fresh Farming’s present value of owning the tractors?
b. What would be Fresh Farming’s present value of leasing the tractors?
c. Should Fresh Farming lease the tractors? Why or why not?
d. Assume that the lessor’s alternative to leasing (i.e. making an investment with similar risk to leasing) is to invest in a 5-year certificate of deposit that pays 9 percent before taxes. Should the lessor write the lease? Why or why not?