LEASE VERSUS BUY Sullivan-Swift Mining Company must install $1.2 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. The equipment falls in the MACKS 3-year class. The applicable MACRS rates are 33%, 45%. 15%, and 7%. 2. Estimated maintenance expenses are $80,000 per year. 3. Sullivan-Swift's federal-plus-state tax rate is 45%. 4. If the money is borrowed, the bank loan will be at a rate of 13%, amortized in 4 equal installments to be paid at the end of each year. 5. The tentative lease terms call for end-of-year payments of $300,000 per year for 4 years. 6. Under the proposed lease terms, the lessee must pay for insurance, property taxes, and maintenance. 7. The equipment has an estimated salvage value of $300,000, which is the expected market value after 4 years, at which time Sullivan-Swift plans to replace the equipment regardless of whether the firm leases or purchases it. The best estimate for the salvage value is $300,000, 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. a. Assuming that the lease can be arranged, should Sullivan-Swift lease or borrow and buy the equipment? Explain. b. Consider the $300,OCX) 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.

BuyFind

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781337395250
BuyFind

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781337395250

Solutions

Chapter
Section
Chapter 20, Problem 5P
Textbook Problem

LEASE VERSUS BUY Sullivan-Swift Mining Company must install $1.2 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 MACKS 3-year class. The applicable MACRS rates are 33%, 45%. 15%, and 7%.
  2. 2. Estimated maintenance expenses are $80,000 per year.
  3. 3. Sullivan-Swift's federal-plus-state tax rate is 45%.
  4. 4. If the money is borrowed, the bank loan will be at a rate of 13%, 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 $300,000 per year for 4 years.
  6. 6. Under the proposed lease terms, the lessee must pay for insurance, property taxes, and maintenance.
  7. 7. The equipment has an estimated salvage value of $300,000, which is the expected market value after 4 years, at which time Sullivan-Swift plans to replace the equipment regardless of whether the firm leases or purchases it. The best estimate for the salvage value is $300,000, 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.

  1. a. Assuming that the lease can be arranged, should Sullivan-Swift lease or borrow and buy the equipment? Explain.
  2. b. Consider the $300,OCX) 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.

Expert Solution

Want to see the full answer?

Check out a sample textbook solution.

Want to see this answer and more?

Experts are waiting 24/7 to provide step-by-step solutions in as fast as 30 minutes!*

*Response times vary by subject and question complexity. Median response time is 34 minutes and may be longer for new subjects.

Additional Business Textbook Solutions

Find more solutions based on key concepts
If a firms ROE is low and management wants to improve it, explain how using more debt might help.

Fundamentals Of Financial Management, Concise Edition (mindtap Course List)

What is the confirmation process?

Accounting Information Systems

What are some pros and cons of holding high levels of current assets in relation to sales? Use the DuPont equat...

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