Whether to lease equipment will be advantageous for WD Company. Introduction: Lease: An asset can be leased or purchased. A lease in a contractual agreement made between two parties; lessor and lessee. The agreement explains the use of asset for a particular time by lessee. In return, lessor gets periodical payments for the use of asset.

Question

Want to see more full solutions like this?

Answer 1

Question

Chapter 27, Problem 9QP

Summary Introduction

To determine: Whether to lease equipment will be advantageous for WD Company.

Introduction:

Lease: An asset can be leased or purchased. A lease in a contractual agreement made between two parties; lessor and lessee. The agreement explains the use of asset for a particular time by lessee. In return, lessor gets periodical payments for the use of asset.

Expert Solution & Answer

Explanation of Solution

Step 1: Determine NAL.

Net advantage to leasing (NAL) is the amount that an individual or a firm saves through leasing an asset instead of purchasing it. The security deposit is a cash outflow. It is a payment made in the beginning of the lease and it is an inflow when the lease is being returned. Therefore, as per the above assumption, NAL is determined as follows:

NAL = Cost?−??PVIFA?of Total?cash?flow?from?leasing = ($8,300,000−?Security?deposit −??$1,237,500−??$1,237,500(PVIFA?4.62%,,4)−$564,400(PVIFA?4.62%,,5)+Security?deposit1.04625)

=($8,300,000−?Security?deposit −??$1,237,500−??$1,237,500×[{1–1/(1+r)t}/r]−$564,400×[{1–1/(1+r)t}/r]+Security?deposit1.04625)

=($8,300,000−?$600,000 −??$1,237,500−??$1,237,500×[{1–1/(1+0.0462)4}/0.0462]−$564,400×[{1–1/(1+0.0462)5}/0.0462]+$60,0001.04625)

=($8,300,000−?$600,000 −??$1,237,500−??$1,237,500×3.57747−$564,400×4.37533+$600,0001.04625)=($8,300,000−?$600,000 −??$1,237,500−??$4,427,119.125−$2,469,436.252+$478,715.7012)NAL=$44,660.3242

Step 2: Determine the present value of the security deposit.

The NAL of the equipment is greater than zero. So, the firm has to lease the equipment with the security deposit. From solution 7, NAL without security deposit can be derived as $165, 927.992. Now, add present value of the security deposit.

Present?value of security deposit = −Security deposit +Security deposit(1+0.0462)5= −$600,000 +?$600,0001.04625=−$600,000 +?$478,715.70116=$121,284.29

Step 3: Determine the NAL with the security deposit.

NAL = NALwithout security deposit −?PV?of?security?deposit=?$165,927.992−$121,284.29=$44,643.702

The NAL with the security deposit is $44,643.702. Hence, the leasing would be advantageous for WD Company.

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Students have asked these similar questions

Q: Which Is the better option to consolidate debt? Option 1: You have a loan at $21,000 at 16.24% (APR) 3 year term, Making the minimum payment monthly. Option 2: You have two loans; 1: $10, 700 at 8.99% (APR), 3 year term, Making the minimum payment monlthy. 2: $ 10,300 at 12.24% (APR), 3 year Term, Making the minimum payment monthly. Which option saves the most in interest, which is the better option to save the most money?

M7 Q4 P1 The R. Morin Construction Company needs to borrow $100,000 to help finance the cost of a new $150,000 hydraulic crane used in the firm's commercial construction business. The crane will pay for itself in one year, and the firm is considering the following alternatives for financing its purchase: Alternative A. The firm's bank has agreed to lend the $100,000 at a rate of 14 percent. Interest would be discounted, and a 15 percent compensating balance would be required. However, the compensating-balance requirement is not binding on the firm because it normally maintains a minimum demand deposit (checking account) balance of $25,000 in the bank. Alternative B. The equipment dealer has agreed to finance the equipment with a 1-year loan. The $100,000 loan requires payment of principal and interest totaling $116,300. a. Which alternative should Morin select? b. If the bank's compensating-balance requirement had necessitated idle demand…

Calculating Flotation Costs [LO4] Suppose your company needs $24 million to build a new assembly line. Your target debt-equity ratio is .75. The flotation cost for new equity is 7 percent, but the flotation cost for debt is only 3 percent. Your boss has decided to fund the project by borrowing money because the flotation costs are lower and the needed funds are relatively small.a. What do you think about the rationale behind borrowing the entire amount?b. What is your company’s weighted average flotation cost, assuming all equity is raised externally?

Answer 2