Accounting

Net advantage to leasing problem (NAL).

ABC Industries is negotiating a lease on a new piece of equipment which would cost $100,000 if purchased. The equipment falls into the MACRS 3-year class, and it would be used for three years and then sold, because ABC plans to move to a new facility at that time. It is estimated that the equipment could be sold for $30,000 after three years of use. A maintenance contract on the equipment would cost $3,000 per year, payable at the beginning of each of the three years of usage. Conversely, ABC could lease the equipment for three years for a lease payment of $29,000 per year, payable at the beginning of each year. The lease would also include maintenance. ABC is in the 20 percent tax bracket, and it could obtain a three-year simple interest loan to purchase the equipment at a before tax cost of 10 percent. Should ABC lease or buy?

NPV LEASE ANALYSIS

Year = 0 1 2 3

Cost of Owning

After-tax loan payments ($8,000) ($8,000) ($108,000)

Maintenance Cost (after tax) ($2,400) ($2,400) ($2,400) $0

Depreciation $33,000 $45,000 $15,000

Tax savings from depr. $6,600 $9,000 $3,000

Residual value $30,000

Tax on residual value ($4,600)

Net cash flow ($2,400) ($3,800) ($1,400) ($79,600)

PV ownership cost @ 8% $ (70,307.84)

Cost of Leasing

Lease payment $29,000 $29,000 $29,000 $0

Tax savings from leas($5,800) ($5,800) ($5,800) $0

Net cash flow $23,200 $23,200 $23,200 $0

PV of leasing @ 8% $ 64,571.74

Cost Comparison

PV ownership cost @ 8% $ (70,307.84)

PV of leasing @ 8% $ 64,571.74

Net Advantage to Leasing $ (5,736.10)

Solution: