BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

Solutions

Chapter
Section
BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

LEASE VERSUS BUY Morris-Meyer Mining Company must install $1.5 million of new machinery in its Nevada mine. It can obtain a bank loan for 100% of the required amount. Alternatively, a Nevada investment banking firm that represents a group of investors believes that it can arrange for a lease financing plan. Assume that the following facts apply:

  1. 1. The equipment falls in the MACRS 3-year class. The applicable MACRS rates are 33%, 45%, 15%, and 7%.
  2. 2. Estimated maintenance expenses are $75,000 per year.
  3. 3. Morris-Meyer’s federal-plus-state tax rate is 40%.
  4. 4. If the money is borrowed, the bank loan will be at a rate of 15%, amortized in 4 equal installments to be paid at the end of each year.
  5. 5. The tentative lease terms call for end-of-year payments of $400,000 per year for 4 years. 6. Under the proposed lease terms, the lessee must pay for insurance, property taxes, and maintenance.
  6. 6. The equipment has an estimated salvage value of $400,000, which is the expected market value after 4 years, at which time Morris-Meyer plans to replace the equipment regardless of whether the firm leases or purchases it. The best estimate for the salvage value is $400,000, but it may be much higher or lower under certain circumstances. To assist management in making the proper lease-versus-buy decision, you are asked to answer the following questions.
  7. a. Assuming that the lease can be arranged, should Morris-Meyer lease or borrow and buy the equipment? Explain.
  8. b. Consider the $400,000 estimated salvage value. Is it appropriate to discount it at the same rate as the other cash flows? What about the other cash flows—are they all equally risky? Explain.

a.

Summary Introduction

To Determine: Whether Company MMM can lease or borrow to buy the equipment by supposing that the lease can be organized.

Introduction: A lease is characterized as an agreement between a lessee and a lessor for the contract of a particular asset for a particular period on payment of determined rents.

Explanation

Determine the after-tax interest rate

AftertaxInterestRate=[BankRate×(1TaxRate)]=[15%×(140%)]=0.09or9%

Therefore the after-tax interest rate is 9%

Determine the present value of cost of owing

Using an excel spreadsheet the present value of cost of owing is determined as -$821,822.60. The maintenance cost is not considered in the calculation because the company has to pay the maintenance cost for the machinery when it buys or leases the machinery.

Excel Spreadsheet:

Excel Workings:

Therefore the present value of cost of owing is -$821,822.60.

Determine the present value of cost of leasing

Using an excel spreadsheet the present value of cost of leasing is determined as $777,532.77

b.

Summary Introduction

To Discuss: Whether it is suitable to discount it at the similar rate as the another cash flow and whether all the other cash flows are equally risk.

Still sussing out bartleby?

Check out a sample textbook solution.

See a sample solution

The Solution to Your Study Problems

Bartleby provides explanations to thousands of textbook problems written by our experts, many with advanced degrees!

Get Started

Additional Business Solutions

Find more solutions based on key concepts

Show solutions add

TIE RATIO AEI Incorporated has 5 billion in assets, and its tax rate is 40%. Its basic earning power (BEP) rati...

Fundamentals of Financial Management, Concise Edition (with Thomson ONE - Business School Edition, 1 term (6 months) Printed Access Card) (MindTap Course List)

What is the function of a cash budget? A capital budget?

Foundations of Business (MindTap Course List)

The word persuasion turns some people off. What negative connotations can it have?

Essentials of Business Communication (MindTap Course List)

Who issues a credit memorandum and why?

College Accounting (Book Only): A Career Approach

What does TELOS stand for? How is it helpful?

Pkg Acc Infor Systems MS VISIO CD

Why will global sourcing increase?

Purchasing and Supply Chain Management

What is a base year?

Economics (MindTap Course List)