Question

Q1) (Lease-versus-purchase analysis) KKR Live, Inc., a carnival operating firm based in Laramie, Wyoming, is considering the acquisition of a new German-made carousel, with a passenger capacity of 30. KKR can purchase the carousel through the use of its normal financing mix (30 percent debt and 70 percent common equity) or lease it. Pertinent details follow:

Acquisition price of the carousel= $25,000
Useful life= 4 years
Salvage value= $5,000
Depreciation method+Straight-line
Annual cash savings before tax and depreciation from the $7,000
carousel Rate of interest on a four-year installment loan=11 percent
Marginal tax rate= 50 percent
Annual rentals (four-year lease) =$7,000
Annual operating expenses included in the lease=$1,250
Cost of capital= 13 %


a. Evaluate whether the carousel acquisition is justified through normal purchase financing.

b. Should KKR lease the asset?

Answer 1

1.)

Year	Annual saving	Interest	Dep	Net savings	After tax	Cash flow	Factor
0	-25000	0	0	-25000	0	-25000	1	-25000
1	7000	825	5000	1175	587.5	5587.5	.884956	4944.69
2	7000	825	5000	1175	587.5	5587.5	.783147	4375.832
3	7000	825	5000	1175	587.5	5587.5	.69305	3872.418
4	7000	825	5000	1175	587.5	5587.5	.613319	3426.918
4	5000			5000	2500	2500	.613319	1533.297
							NPV =	-6846.84

Carousel acquisition is not justifies through normal purchase financing.

2.)

Year	Annual savings	Net lease Payment	Cash flow
1	7000	5750	1250	625	.884956	553.097
2	7000	5750	1250	625	.783147	489.466
3	7000	5750	1250	625	.69305	433.156
4	7000	5750	1250	625	.613319	383.324
					NPV=	1859.044

KKR should lease the asset