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.