A used piece of heavy equipment is available for purchase at $300K. A rental company is deciding whether or not to purchase the equipment. The company estimates the equipment will create annual incomes of $110K and have annual operating costs of $20K. The equipment can be depreciated in five years with straight line depreciation. Based on the results from part a) below, should the rental company purchase the equipment if their corporate tax rate is 35%? consider a five year life project and an after tax marr of 15%.
a)Determine the return on equity for each of three different leverage factors of 0, 0.4, and 0.7. Assume an interest rate on borrowed funds to be 10% compounded annually. The principal payments will be constant for each of the five years and the interest paid each year will be based on the outstanding debt balance.
b) before tax IRR?
after tax IRR with leverage factor=0?
after tax IRR with leverage factor=0.4?
after tax IRR with leverage factor=0.7?
Should they purchase the equipment?