Concept explainers
Lease or Buy High electricity costs have made Farmer Corporation’s chicken-plucking machine economically worthless. Only two machines are available to replace it. The International Plucking Machine (IPM) model is available only on a lease basis. The lease payments will be $80,000 for five years, due at the beginning of each year. This machine will save Farmer $29,000 per year through reductions in electricity costs. As an alternative, Farmer can purchase a more energy-efficient machine from Basic Machine Corporation (BMC) for $365,000. This machine will save $32,000 (1 per year in electricity costs. A local bank has offered to finance the machine with a $365,000 loan. The interest rate on the loan will be 10 percent on the remaining balance and will require five annual principal payments of $73,1100. Farmer has a target debt-to-asset ratio of 67 percent. Farmer is in the 34 percent tax bracket. After five years, both machines will be worthless. The machines will be
- a. Should Farmer lease the IPM machine or purchase the more efficient BMC machine?
- b. Does your answer depend on the form of financing for direct purchase?
- c. How much debt is displaced by this lease?
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FINANCE 601 ACCESS CODE (CUSTOM)
- Dauten is offered a replacement machine which has a cost of 8,000, an estimated useful life of 6 years, and an estimated salvage value of 800. The replacement machine is eligible for 100% bonus depreciation at the time of purchase- The replacement machine would permit an output expansion, so sales would rise by 1,000 per year; even so, the new machines much greater efficiency would cause operating expenses to decline by 1,500 per year The new machine would require that inventories be increased by 2,000, but accounts payable would simultaneously increase by 500. Dautens marginal federal-plus-state tax rate is 25%, and its WACC is 11%. Should it replace the old machine?arrow_forwardA physics lab is considering leasing a diagnostic scanner that costs $5,800,000, and it would be depreciated straight-line to zero over four years. Because of radiation contamination, it will actually be completely valueless in four years. You can lease it for four years. Assume tax rate is 21% for the leasing company (lessor) and zero for the lab. The cost of borrowing is 8%. Over what range of lease payments will the lease be profitable for both lessee and lessor? handwrite pleasearrow_forwardThe Capitalpoor Company is considering purchasing a business machine for $100,000. An alternative is to rent it for $35,000 at the beginning of each year. The rental would include all repairs and service. If the machine is purchased, a comparable repair and service contract can be obtained for $1,000 per year. The salesperson of the business machine firm has indicated that the expected useful service life of this machine is five years, with zero market value, but the company is not sure how long themachine will actually be needed. If the machine is rented, the company can cancel the lease at the end of any year. Assuming an income tax rate of 25%, a straight-line depreciation charge of $20,000 for each year the machine is kept, and an after-tax MARR of 10%, prepare an appropriate analysis to help the firm decide whether it is more desirable to purchase or rent.arrow_forward
- A small strip-mining coal company is trying to decide whether it should purchase or lease a new clamshell. If purchased, the “shell” will cost $150,000 and is expected to have a $65,000 salvage value after 6 years. Alternatively, the company can lease a clamshell for only $20,000 per year, but the lease payment will have to be made at the beginning of each year. If the clamshell is purchased, it will be leased to other strip-mining companies whenever possible, an activity that is expected to yield revenues of $12,000 per year. If the company’s MARR is 15% per year, should the clamshell be purchased or leased on the basis of a future worth analysis? Assume the annual M&O cost is the same for both options.arrow_forwardDell is considering replacing one of its material handling systems. It has an annual O&M cost of $48,000, a remaining operational life of 8 years, and an estimated salvage value of $6,000 at that time. A new system can be purchased for $175,000. It will be worth $50,000 in 8 years, and it will have annual O&M costs of only $17,000 per year due to new technology. If the new system is purchased, the old system will be traded in for $55,000, even though the old system can be sold for only $45,000 on the open market. Leasing a new system will cost $31,000 per year, payable at the beginning of the year, plus operating costs of $15,000 per year payable at the end of the year. If the new system is leased, the existing material handling system will be sold for its market value of $45,000. Use a planning horizon of 8 years, an annual worth analysis, and MARR of 15% to decide which material handling system to recommend: (i) keep existing, (ii) trade in existing and purchase new, or (iii)…arrow_forwardBe-low Mining, Inc., is trying to decide whether it should purchase or lease new earthmoving equipment. If purchased, the equipment will cost $175,000 and will be used 6 years, at which time it can be sold for $72,000. At Year 3, an overhaul costing $20,000 must be performed. The equipment can be leased for $30,000 per year. Be-low will not be responsible for the midlife overhaul if the equipment is leased. If the equipment is purchased, it will be leased to other mining companies when possible; this is expected to yield revenues of $15,000 per year. The annual operating cost regardless of the decision will be approximately equal. What would you recommend if the MARR is 6%?arrow_forward
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