Question

A firm in the transportation industry 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. 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 the firm 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 (rental) payment (4 payments total) at the beginning of each year. Firm's tax rate is 40%. What is the net advantage to leasing? (Note: Assume MACRS rates for Years 1 to 4 are 0.33, 0.45, 0.15, and 0.07).

Answer #1

Answer:

First, leasing it. We can write off 40% so each payment = 6,000 in total cost.

Lease: 6000 + 6000/1.06 + 6000/1.06 ^ 2 + 6000/1.06 ^ 3 = 22038.07

Now owning.

Cost now = 40,000.

Maintenance costs us 600 a year due to being able to write off 40%

Depreciation savings will be 40% of value of depreciation. So Y 1 = 40000*.3333*.4, Y 2 = 40000*.4445*.4, Y 3 = 40000*.15*.4, Y 4 = 40000*.07*.4. Finally we get 6000 from the sale (4000 is taxes).

Now put it all together in present value terms

40000 + (-40000*.33*.4 + 600) / 1.06 + ( - 40000*.45*.4 + 600) / 1.06 ^ 2 + (-40000*.15*.4 + 600) / 1.06 ^ 3 + ( - 40000*.07*.4 + 600-6000) / 1.06 ^ 4 = 23035.17

23035.17?22038.07 = $996.9 or about $997.

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