As a financial analyst for Sara Construction, you have been asked to recommend the method of financing the acquisition of new equipment needed by the firm. The installed cost of this equipment would be $350,000 and the equipment will be depreciated on a straight-line basis over a 5-year estimated useful life. At the end of five years, the equipment would have a salvage value of $50,000. If purchased, the company would incur additional pre-tax operating costs of $10,000 per year, and the needed capital can be borrowed at a10 percent pre-tax annual rate. The company is in the 40% tax bracket. Should the company choose to purchase the equipment rather than lease it? Pre-tax lease payments are 80,000 per year for the next five years, with the payments being made at the end of each year. Required: Compute the net advantage to leasing (NAL). Should the firm lease or own the equipment? What are the primary differences between operating leases and financial leases? What effect does leasing have on a firm’s balance sheet? What effect does leasing have on a firm’s capital structure?
As a financial analyst for Sara Construction, you have been asked to recommend the method of financing the acquisition of new equipment needed by the firm. The installed cost of this equipment would be $350,000 and the equipment will be depreciated on a straight-line basis over a 5-year estimated useful life. At the end of five years, the equipment would have a salvage value of $50,000. If purchased, the company would incur additional pre-tax operating costs of $10,000 per year, and the needed capital can be borrowed at a10 percent pre-tax annual rate. The company is in the 40% tax bracket. Should the company choose to purchase the equipment rather than lease it? Pre-tax lease payments are 80,000 per year for the next five years, with the payments being made at the end of each year. Required: Compute the net advantage to leasing (NAL). Should the firm lease or own the equipment? What are the primary differences between operating leases and financial leases? What effect does leasing have on a firm’s balance sheet? What effect does leasing have on a firm’s capital structure?
Chapter19: Lease And Intermediate-term Financing
Section: Chapter Questions
Problem 8P
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Question
As a financial analyst for Sara Construction, you have been asked to recommend the method of financing the acquisition of new equipment needed by the firm. The installed cost of this equipment would be $350,000 and the equipment will be
Should the company choose to purchase the equipment rather than lease it? Pre-tax lease payments are 80,000 per year for the next five years, with the payments being made at the end of each year.
Required:
- Compute the net advantage to leasing (NAL).
- Should the firm lease or own the equipment?
- What are the primary differences between operating leases and financial leases?
- What effect does leasing have on a firm’s
balance sheet ? - What effect does leasing have on a firm’s capital structure?
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