Problem:
Sandia Meadows, Inc wants to install $2.8 million of new equipment to update its ski lifts. The company can obtain a bank loan for 100% of the purchase price or it can lease the equipment. Assume the following:
. The machinery falls into the MACRS 3 year class
. Estimated maintenance expenses are $90k per year, payable at the beginning of each year.
. The Company's tax rate is 35%
. The lease terms call for $480k payments at the end of the next 4 years
. Under either the Lease or the Purchase, Sandia Meadows, Inc. must pay for insurance, property taxes and maintenance.
. Assume that Sandia Meadows will continue to use the equipment beyond the expiration of the lease and must purchase it at an estimated residual value of $230k at the end of year 4.
What does Sandia Meadows do? Lease or buy the equipment.
Please explain your answers in detail.
| Cost of Owning |
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| 1. After tax loan payments |
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| 2. Maintenance costs |
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| 3. Maintenance tax savings |
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| 4. Depreciation tax savings |
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| 5. Residual value |
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| 6. Tax on residual value |
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| 7. Net cash flow |
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| 8. PV ownership CF @ ? |
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| 9. Cost of ownership |
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| Cost of Leasing |
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| 10. Lease payment |
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| 11. Tax savings from lease |
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| 12. Net cash flow |
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| 13. PV of leasing CF @?% |
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| 14. Cost of leasing |
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| NAL=Cost of ownership-cost of leasing |
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