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Net Advantage To Leasing

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As part of its overall plant modernization and cost reduction program, Western Fabrics' management has decided to install a new automated weaving loom. In the capital budgeting analysis of this equipment, the IRR of the project was found to be 20% versus a project required return of 12%.
The loom has an invoice price of $250,000, including delivery and installation charges. The funds needed could be borrowed from the bank through a 4-year amortized loan at a 10% interest rate, with payments to be made at the end of each year. In the event that the loom is purchased, the manufacturer will contract to maintain and service it for a fee of $20,000 per year paid at the end of each year. The loom falls in the MACRS 5-year class, and Western's marginal federal-plus-state tax rate is 40%.

Gardial Automation Inc., maker of the loom, has offered to lease the loom to Westen for $70,000 upon delivery and installation (at t=0) plus 4 additional annual lease payments of $70,000 to be made at the ends of Years 1 through 4. (Note that there are 5 lease payments in total.) The lease agreement includes maintenance and servicing. Actually, the loom has an expected life of eight years, at which time its expected salvage value is zero; however, after 4 years, its market value is expected to equal its book value of $42,500. Tanner-Woods plans to build and entirely new plant in 4 years, so it has no interest in either leasing or owning the proposed loom for more than that period.

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Using an Excel spreadsheet, this solution illustrates the computation of the net advantage to leasing.

See Also This Related BrainMass Solution

Net Advantage to Leasing; Reverse Splt

A.The financial manager of Time Press Inc. is considering installing a printing machine for $400,000. The machine will be depreciated using straight line method with zero residual value over a period of 4 years. Alternatively, the firm can lease the printing machine with an annual lease payment of $132,000 over 4 years. The corporate tax rate is 40%. Assume the firm can borrow at 10% before taxes.

i) Should the firm buy or lease the printing machine? support your answer with computations
ii) Determine the maximum annual lease payment that the firm will pay to rent the printing machine.
iii) During the board meeting, the CFO made the following statement: "If the tax advantages of leasing were eliminated, leasing would disappear. " How would you respond? Explain.

b. Explain whether you agree with the following claim from the chief executive officer during the board meeting: 'It is a good suggestion to have a reverse split if we wish to raise the share price of the firm.

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