Exam 19: Lease Financing

From the lessee viewpoint,the riskiness of the cash flows,with the possible exception of the residual value,is about the same as the riskiness of the lessee's

Carmichael Cleaners needs a new steam finishing machine that costs $100,000.The company is evaluating whether it should lease or purchase the machine.The equipment falls into the MACRS 3-year class,and it would be used for 3 years and then sold,because the firm plans to move to a new facility at that time.The estimated value of the equipment after 3 years is $30,000.A maintenance contract on the equipment would cost $3,000 per year,payable at the beginning of each year.Alternatively,the firm could lease the equipment for 3 years for a lease payment of $29,000 per year,payable at the beginning of each year.The lease would include maintenance.The firm is in the 20% tax bracket,and it could obtain a 3-year simple interest loan,interest payable at the end of the year,to purchase the equipment at a before-tax cost of 10%.If there is a positive Net Advantage to Leasing the firm will lease the equipment.Otherwise,it will buy it.What is the NAL? (Note: Assume MACRS rates for Years 1 to 4 are 0.3333,0.4445,0.1481,and 0.0741.)

To finance some manufacturing tools it needs for the next 3 years,Waldrop Corporation is considering a leasing arrangement.The tools will be obsolete and worthless after 3 years.The firm will depreciate the cost of the tools on a straight-line basis over their 3-year life.It can borrow $4,800,000,the purchase price,at 10% and buy the tools,or it can make 3 equal end-of-year lease payments of $2,100,000 each and lease them.The loan obtained from the bank is a 3-year simple interest loan,with interest paid at the end of the year.The firm's tax rate is 40%.Annual maintenance costs associated with ownership are estimated at $240,000,but this cost would be borne by the lessor if it leases.What is the net advantage to leasing (NAL),in thousands? (Suggestion: Delete 3 zeros from dollars and work in thousands.)