I don't understand how to incorporate the 70% owner's equity and 30% debt into the calculation. Can you please provide me step by step instructions on how to solve this question correctly or provide me with the solutions so I can verify it where I went wrong.
The firm, Hard Removals, is operated by a sole proprietor, and is considering the purchase of a new truck to haul its large rubbish removal skips. The firm is presently financed by a mix of 70% owner's equity and 30% debt, the after tax cost of capital being 12%. Pertinent details are given below:
Acquisition price of truck $ 20,000
Useful life 4 years
Salvage value (estimate) $ 4,000
Depreciation method, down to zero book value Straight line
Annual cash savings from the truck, before tax and depreciation
Rate of interest on a 4 year term loan 10% pa
Marginal tax rate 47%
Annual lease rentals (4 years) payable at the beginning of each year
Residual lease value $ 7,000
Annual operating expenses paid by lessor $ 1,000
a. Evaluate whether or not the truck acquisition is justified as an investment project.
b. Should Hard Removals lease or buy the truck?
The calculations needed to analyze the options to lease or buy the truck are explained in good detail.