Question

Kohlers Inc. is considering a leasing arrangement to finance some manufacturing tools that it needs for the next three years. The tools will be obsolete and worthless after three years. The firm will depreciate the cost of the tools over their three-year MACRS class life (.33, .45, .15, .07). Kohlers can borrow $4,800,000, the purchase price, at 10% and buy the tools, or it can make three equal, end-of-the-year payments of $2,100,000 each and lease them. The loan is a 3-year simple interest loan, with interest paid at the end of each year. The firm's tax rate is 40%. Annual maintenance costs associated with ownership are estimated at $240,000, but this cost would be covered by the lessor if Kohler leases. What is the net advantage to leasing (NAL), in thousands? (drop three zero's in your calculations.)

Answer 1

	Lease	Buy
Borrow		4,800,000
Interest		10%
Annual payment	2,100,000	480,000
Year 3 payment		4,800,000
Annual Maintenance	-	240,000
Depreciation	No	Yes
Tax rate	40%	40%
After tax lease payments	=2100000*(1-40%)
After tax lease payments	1,260,000
Tax benefit on Depreciation
Year		1	2	3
Interest		480,000	480,000	480,000
Maintenance		240,000	240,000	240,000
Depreciation		33%	45%	15%
Depreciation		1,584,000	2,160,000	720,000
Total Expense		2,304,000	2,880,000	1,440,000
tax @ 40%		921,600	1,152,000	576,000
After tax expense		1,382,400	1,728,000	864,000
Less Depreciation		(1,584,000)	(2,160,000)	(720,000)
Cash Expense		(201,600)	(432,000)	144,000
Cost		4,800,000
Depreciation in 3 years (calculated above)		4,464,000
After 3rd year WDV		336,000
Sale price		0
Loss		336,000
Tax saving @ 40%		134,400
Cash flow in Purchase
Year		1	2	3
Cash expense		(201,600)	(432,000)	144,000
Loan repayment				4,800,000
Tax saving on WDV				(134,400)
Cash flows		(201,600)	(432,000)	4,809,600
After tax lease payments		1,260,000	1,260,000	1,260,000
Advantage		(1,461,600)	(1,692,000)	3,549,600
Total advantage		396 K