19-1
a. (1) Reynolds’ current debt ratio is $400/$800 = 50%.
(2) If the company purchased the equipment its balance sheet would look like:
Current assets
Fixed assets
Leased equipment
Total assets
$300
500
200
$1,000
Debt (including lease) $600
Equity
Total claims
$400
$1,000
Therefore, the company’s debt ratio = $600/$1,000 = 60%.
(3) If the company leases the asset and does not capitalize the lease, its debt ratio =
$400/$800 = 50%.
b. The company’s financial risk (assuming the implied interest rate on the lease is
equivalent to the loan) is no different whether the equipment is leased or purchased.
19-2
Cost of owning:
Cost
Depreciation shield
0
1
2
|
|
|
(200)
40
40
40
40
0
1
2
|
|
|
(66)
(66)
(200)
PV at 6% = -$127.
Cost of leasing:
After-tax lease payment
PV at 6% = -$128.
NAL = −$128 – (−$127) = −$1.
Reynolds should buy the equipment, because the cost of owning is less than the cost of
leasing.
19-3
a. Balance sheets before lease is capitalized:
Energen
Balance Sheet (Owns new assets)
(Thousands of Dollars)
Current assets
$ 25,000
Debt
Fixed assets
175,000
Equity
Total assets
$200,000
$100,000
100,000
Total claims $200,000
Debt/assets ratio = $100/$200 = 50%.
Hastings Corporation
Balance Sheet (Leases as operating lease)
(Thousands of Dollars)
Current assets
$ 25,000
Debt
$ 50,000
Fixed assets
125,000
Equity
100,000
Total assets
$150,000
Total claims $150,000
Debt/assets ratio = $50/$150 = 33%.
b. Balance sheet after lease is capitalized:
Hastings Corporation
Balance Sheet (Capitalizes lease)
(Thousands of Dollars)
Current assets
Value of leased asset
$ 25,000
50,000
Fixed assets
125,000
Total assets
$200,000
Debt/assets ratio = $100/$200 = 50%.
19-4
Debt
PV of lease payments
Equity
Total claims
$ 50,000
50,000
100,000
$200,000
I. Cost of Owning:
0
After-tax loan paymentsa
Depr. tax savingsb
Residual value
Tax on residual
Net cash flow
1
($135,000)
$199,980
$0
2
($135,000)
$266,700
3
($135,000)
$88,860
$131,700
($46,140)
4
($1,635,000)
$44,460
$250,000
($100,000)
($1,440,540)
3
(240,000)
(240,000)
4
(240,000)
(240,000)
$4,980
PV of owning at 9% = −$885,679.47
II. Cost of Leasing:
0
Lease payment (AT)
Net cash flow
1
(240,000)
(240,000)
$0
2
(240,000)
(240,000)
PV of leasing at 9% = −$777,532.77
III. Cost Comparison
Net advantage to leasing (NAL)= PV of leasing - PV of owning
= −$777,532.77 – (−$885,679.47)
= $108,146.69.
a
After-tax interest payments = (0.15)($1,500,000)(1-0.40) = $135,000.
Depreciation tax savings, base on MACRS 3-year life and $1,500,000 cost of new
machinery:.
b
Year
1
2
3
4
19-5
MACRS
Allowance Factor
0.3333
0.4445
0.1481
0.0741
Deprec. Tax Savings
Depreciation
T (Depreciation)
$499,950
$199,980
666,750
266,700
222,150
88,860
111,150
44,460
Since the cost of leasing the machinery is less than the cost of owning it, Big Sky Mining
should lease the equipment.
a. Borrow and buy analysis:
Depreciation Schedule of New Equipment
Year
Depreciation rates for
new purchase
0
1
2
3
4
33.33%
44.45%
14.81%
7.41%
Depreciation
333,300
444,500
148,100
74,100
Book Value
666,700
222,200
74,100
-
5
6
Amortization Schedule of Loan
Year
0
1
2
3
4
5
6
Loan payment
257,157.5
257,157.5
257,157.5
257,157.5
257,157.5
257,157.5
Interest
140,000.0
123,598.0
104,899.6
83,583.5
59,283.2
31,580.7
Principal
117,157.5
133,559.5
152,257.9
173,574.0
197,874.3
225,576.8
1,000,000
882,842.5
749,283.0
597,025.1
423,451.1
225,576.8
0.0
0
1
-257,157.5
47,600.0
2
-257,157.5
42,023.3
3
-257,157.5
35,665.9
4
-257,157.5
28,418.4
5
-257,157.5
20,156.3
6
-257,157.5
10,737.5
113,322.0
151,130.0
50,354.0
25,194.0
0.0
0.0
-96,235.5
-64,004.2
-171,137.6
-203,545.1
-237,001.2
-246,420.0
Ending Loan Balance
Cost of Owning
Year
Loan payments
Interest tax savings
Depreciation Tax
savings
Purchase of
equipment
Loan proceeds
Net cash flow
PV @ after-tax cost
of debt
-1,000,000
1,000,000
0.00
-713,300
Depreciation Schedule of Used Equipment
Year
Depreciation Schedule
for used purchase
Depreciation
Book Value
0
1
2
3
4
5
6
200,000
33.33%
66,660
133,340
44.45%
88,900
44,440
14.81%
29,620
14,820
7.41%
14,820
0
Cost of Leasing
Year
After-tax lease payment
Market value of machine
Depreciation tax savings
Net cash flow
PV @ after-tax cost of
debt
Net advantage to leasing
0
0.00
1
-184,800.0
-184,800.0
2
-184,800.0
-184,800.0
3
-184,800.0
-200,000.0
-22,664.4
-407,464.4
4
5
6
-30,226.0
-30,226.0
-10,070.8
-10,070.8
-5,038.8
-5,038.8
-667,261
46,039
Net advantage to leasing = −667,261 – (−713,300) = 46,039.
Because the NAL is positive, the company should choose the lease.
Note that the maintenance expense is excluded from the analysis since the firm will
have to bear the cost whether it buys or leases the machinery.