Problem:
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
$ 10,000
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
$ 6,000
Residual lease value $ 7,000
Annual operating expenses paid by lessor $ 1,000
Q1. Evaluate whether or not the truck acquisition is justified as an investment project.
Q2. Should Hard Removals lease or buy the truck?