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Lease vs Buy Decision Discussed

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XYZ is trying to determine to lease or buy a new computer system. Tax rate is 35%and the cost of debt is 5.5%(after tax).
Lease-Annual beginning of the year payments of payments of 25,000 are required over 5 years. The lessor wil pay maintenance costs, the lessee will pay insurance and other cost. The lessee will exercise its option to purchase the asset for 32,000 in the final lease payment.
Purchase-The $100,000 cost can be financed entirely with 7.5% loan requiring end of year payments of 24,316 for five years. The MACRS five year recovering program will be used. The firm will pay $3500 per year for a service contract; the firm will pay insurance and other costs. The firm plans to keep the equipment beyond its 5 year life.
Should they lease or buy?

How would set this up in excel?

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The solution provides answer to a Lease versus Buy Decision.

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Please see the attached file.

a) Calculate the after-tax cash outflows associated with each alternative.

Purchase:
Let us calculate the amount of interest payment each year

Note: There appaears to be a mistake in data . The annual debt repayment should be 24716 and not 24316

n= 5
r= 7.50%
PVIFA (5 periods, 7.5% rate ) = 4.045885
Value of debt= $100,000
Therefore annuity= $24,716 =$100,000/4.045885

interest rate= 7.50%
Year Payment Principal at the beginning of year interest Amortization of loan Principal at the end of year
0
1 $24,716 $100,000 $7,500 $17,216 $82,784
=0.075 x 100000 =24716 -7500 =100000 -17216
2 $24,716 $82,784 $6,209 $18,507 $64,277
3 $24,716 $64,277 $4,821 $19,895 $44,382
4 $24,716 $44,382 $3,329 $21,387 $22,995
5 $24,716 $22,995 $1,725 $22,991 $4 (This should be zero, this error is rounding off error)

Tax shield = tax rate x interest payment, is available on interest payments

Tax ...

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