FIN-516 WEEK 5 – HOMEWORK – CHAPTER 18
Lease vs. Purchase Analysis Problem
Dakota Trucking Company (DTC) is evaluating a potential lease for a truck with a 4-year life that costs $40,000 and falls into the
MACRS 3-year class. If the firm borrows and buys the truck, the loan rate would be 10%, and the loan would be amortized over the
truck’s 4-year life, so the interest expense for taxes would decline over time.
The loan payments would be made at the end of each year. The truck will be used for 4 years, at the end of which time it will be
sold at an estimated residual value of $10,000. If DTC buys the truck, it would purchase a maintenance contract that costs $1,000
per year, payable at the end of each year.
The lease terms, which include maintenance, call for a $10,000 lease payment (4 payments total) at the beginning of each year.
DTC's tax rate is 40%.
Should the firm lease or buy?
What is the Net Advantage of Leasing (if any)?
(Note: MACRS rates for Years 1 to 4 are 0.33, 0.45, 0.15, and 0.07.)
Principal PMTs = PPMT (0.1, 1, 4,-40000); = PPMT (0.1, 2, 4,-40000); = PPMT (0.1, 3, 4,-40000); = PPMT (0.1, 4, 4,-40000)
Interest PMTs = IPMT (0.1, 1, 4,-40000); = IPMT (0.1, 2, 4,-40000); = IPMT (0.1, 3, 4,-40000); = IPMT (0.1, 4, 4,-40000)
TS on IPMT = Year X Interest PMT * 0.40
Depr. = $40,000 * MACRS rates for Years 1 to 4 are 0.33, 0.45, 0.15, and 0.07
TS on Depr. = Year X Depr * 0.40
Cost of Purchase
Year 1
Year 2
Year 3
Year 4
Total
Principal PMTs
$
8,618.83
$
9,480.72
$ 10,428.79
$ 11,471.67
$
Interest PMTs
$ 4,000.00
$ 3,138.12
$ 2,190.05
$ 1,147.17
TS on IPMT
$ 1,600.00
$ 1,255.25
$ 876.02
$ 458.87
Depr.
$ 13,200.00
$ 18,000.00
$ 6,000.00
$ 2,800.00
Cost of Lease
Total
Lease PMT
$ 10,000.00
$ 10,000.00
$ 10,000.00
$ 10,000.00
$
Maint.
Resale
$ 1,000.00
$ 1,000.00
$ 1,000.00
$ 1,000.00 $ 10,000.00
Cost
$ 6,738.83
$ 5,163.59
$ 10,342.81
$ 2,039.97
40,000.00 $ 10,475.33 $ 4,190.13 $ 40,000.00 $ 16,000.00 $ 4,000.00 $ 10,000.00 $ 24,285.20
PV of Cost of Purchase = PV (Rate, Period,, - Future Value)
PV of Cost of Purchase = PV (0.10, 4,, - $24285.20)
PV of Cost of Purchase = $16,587.12
Year 1
Year 2
Year 3
Year 4
TS on Depr.
$ 5,280.00
$ 7,200.00
$ 2,400.00
$ 1,120.00
TS from Lease
$ 4,000.00
$ 4,000.00
$ 4,000.00
$ 4,000.00
Cost
$ 6,000.00
$ 6,000.00
$ 6,000.00
$ 6,000.00
40,000.00 $ 16,000.00 $ 24,000.00
PV of Cost of Lease = PV (Rate, Period,, - Future Value)
PV of Cost of Lease = PV (0.10, 4,, -$24000.00)
PV of Cost of Lease = $16,392.32
Net Advantage of Lease = PV of Cost of Purchase – PV of Cost of Lease
Net Advantage of Lease = $16,587.12 – $16,392.32
Net Advantage of Lease = $194.80
Dakota Trucking Company (DTC) should lease the truck because there is a net advantage from the lease
of $194.80. The net advantage from the lease savings coupled with the limitation of risk the lease
provides make it a better option.