Question

# High electricity costs have made Farmer Corporation’s chicken-plucking machine economically worthless. Only two machines are available...

 High electricity costs have made Farmer Corporation’s chicken-plucking machine economically worthless. Only two machines are available to replace it. The International Plucking Machine (IPM) model is available only on a lease basis. The lease payments will be \$97,000 for five years, due at the beginning of each year. This machine will save Farmer \$37,500 per year through reductions in electricity costs. As an alternative, Farmer can purchase a more energy-efficient machine from Basic Machine Corporation (BMC) for \$450,000. This machine will save \$40,500 per year in electricity costs. A local bank has offered to finance the machine with a \$450,000 loan. The interest rate on the loan will be 9 percent on the remaining balance and will require five annual principal payments of \$90,000. Farmer has a target debt-to-asset ratio of 54 percent and a tax rate of 22 percent. After five years, both machines will be worthless. The machines will be depreciated on a straight-line basis.
 a. What is the NAL of leasing? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) b. How much debt is displaced by this lease? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

a. NAL of leasing First Machine

Five payments of \$ 97000 at the beginning of each year for five years

Rate = 9%

Cost of Machine taken on lease = 97000*5 = 485000

Net profit to farmer if machine taken on lease

 Total of Lease Installments (97000*5) 485000 Less: Electricity saving (37500*5) 187500 Less: tax saving on Dep Calculation of Dep = 485000/5 = 97000 tax rate = 22% i.e. 21340 for 5 years = 21340*5 = 106700 106700 Net Cost of leasing 190800

NAL in case of purchase of machinery

 Cost of MAchinery 450000 Interest on Machinery 121500 Less: Electricity savings for Five years 40500*5 202500 Less: tax Saving on Dep SLM method dep will be 90000 per year tax rate is 22% annual saving 90000*22% = 19800 per year for 5 year = 19800*5 99000 Net cost of purchase the machine 270000

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