Reference no: EM132877722
PROBLEM 1 - A HCA hospital in Colorado plans to obtain a new MRI that costs $1.5 million and has an estimated four-year useful life. It can obtain a bank loan for the entire amount and buy the MRI, or it can obtain a guideline lease for the equipment. Assume that the following facts apply to the decision
- The MRI falls into the three-year class for tax depreciation, so the MACRS allowances are 0.33, 0.45, 0.15, and 0.07 in Years 1 through 4, respectively.
- Estimated maintenance expenses are $75,000 payable at the beginning of each year whether the MRI is leased or purchased.
- HCA's marginal tax rate is 40 percent.
- The bank loan would have an interest rate of 15 percent.
- If leased, the lease payments would be $400,000 payable at the end of each of the next four years.
- The estimated residual (and salvage) value is $250,000.
a. What are the NAL and IRR of the lease? Interpret each value.
PROBLEM 2 - West Hills Village (WHV) in Rapid City, South Dakota is evaluating a guideline lease agreement on laundry equipment that costs $250,000 and falls into the MACRS three-year class. The home can borrow at an 8 percent rate on a four-year loan if WHV decided to borrow and buy rather than lease. The laundry equipment has a four-year economic life, and its estimated residual value is $50,000 at the end of Year 4. If WHV buysthe equipment, it would purchase a maintenance contract which costs $5,000 per year, payable at the beginning of each year. The lease terms, which include maintenance, call for a $71,000 lease payment at the beginning of each year. WNV's tax rate is 40 percent. Should the home lease or buy?
When assessing and determining whether to lease or buy a specific piece of equipment, begin with what you know.
For example for Problem 1, following are the givens:
Purchasing Option
Purchase Price $1,500,000
Yearly Maintenance $ 75,000
Maintenance Tax Savings 40% of the Maintenance Costs
Depreciation Percent for each of the 4 years 33%, 45%, 15% and 7%
Residual Value $ 250,000
Bank Loan Interest 15%
Example: To determine depreciation tax savings:
For Year 1: Purchase Price X 40% X 33%
Leasing Option
Yearly Cost of the Lease Years 1-4 $400,000
Tax Savings 40% of yearly cost
Yearly Maintenance Costs $75,000 (same as for a purchase)
Maintenance Tax Savings 40% of maintenance cost (same as for a purchase)
Utilizing the formula for NPV will provide the PV of the cost leasing vs. the PV of the cost of owning
Determining the IRR for the leasing option, can be compared to the after tax interest on the loan to purchase - remember the interest on the loan is decreased by the overall tax deduction of 40%
For Problem 2, first list what is known for both purchasing and leasing, calculate the maintenance tax savings, and the depreciation tax savings, use NPV formula to determine the PV cost of leasing and the PV cost of owning, determine the leasing IRR and compare with the after tax loan percent.
Taking each step at a time, developing a table for Year 0 (purchase year) and for each of the 4 subsequent years, and for leasing a table for each of the 4 years will help you organize the different calculations.