Professional Documents
Culture Documents
Problem Set 5
Due on or before Day 6 (Monday)
Assigned Problem 1
Reynolds Construction needs a piece of equipment that costs $200. Reynolds can either lease the equipment or
borrow $200 from a local bank and buy the equipment. If the equipment is leased, the lease would not have to
be capitalized. Reynolds s balance sheet prior to the acquisition of the equipment is as follows:
Current assets
Fixed assets
Total assets
300
500
800
Debt
Equity
Total claims
400
400
800
$600
$400
$1,000
Assigned Problem 2
Delmont Transport Company (DTC) is evaluating the merits of leasing versus purchasing a truck with a 4-year
life that costs $40,000 and falls into the MACRS 3-year class. If the firm borrows and buys the truck, the loan
rate would be 10%, and the loan would be amortized over the truck's 4-year life, so the interest expense for
taxes would decline over time. The loan payments would be made at the end of each year. The truck will be
used for 4 years, at the end of which time, it will be sold at an estimated residual value of $10,000. If DTC buys
the truck, it would purchase a maintenance contract that costs $1,000 per year, payable at the end of each year.
The lease terms, which include maintenance, call for a $10,000 lease payment at the beginning of each year (i.e.
4 payments total). DTC's tax rate is 40%.
What is the net advantage to leasing?
(Note: Assume MACRS rates for Years 1 to 4 are 0.3333, 0.4445, 0.15, and 0.07.)
Cost
MACRS rates
0.3333
$13,332 (year 1)
0.4445
$17,780 (year 2)
0.15
$6,000 (year 3)
0.07
$2,800 (year 4)
$40,00
0
$40,00
0
$40,00
0
$40,00
0
Purchasing
Tax benefit on
Maintenance
Present value
YEAR
Installment
Depreciation
depreciation
contract/yr
Cash flow
factor at 10%
PV of Cash flow
$12,174
$13,332
$5,333
$1,000
$7,841
0.91
$7,128
$12,174
$17,780
$7,112
$1,000
$6,062
0.83
$5,010
$12,174
$6,000
$2,400
$1,000
$10,774
0.75
$8,095
$12,174
$2,800
$1,120
$1,000
$12,054
0.68
$8,233
(10,000)
0.68
(6,830)
salvage value,
year 4
PV Total cash
flows
$21,636
Leasing
Present
Tax
value
Present
Lease
benefit on
Cash
factor at
value of
YEAR
payment
lease
flow
10%
cash flow
$10,000
$4,000
$6,000
0.91
$5,455
$10,000
$4,000
$ 6,000
0.83
$4,959
$10,000
$4,000
$6,000
0.75
$4,508
$10,000
$4,000
$6,000
0.68
$4,098
$19,020
The present value cash flow for purchasing the truck is $21,636 and for leasing is $19,020.
The net advantage to leasing is $2,616