Greenville Electric Corp. is a public utility firm which pays no taxes. Its credit rating is...

Transcribed Image Text:

Greenville Electric Corp. is a public utility firm which pays no taxes. Its credit rating is Aaa, guaranteed by the city of Greenville. And thus, its loan borrowing rate is 6%. Greenville Electric has decided that it needs a new equipment. Greenville can either lease or buy the equipment. The equipment costs $10,000,000 and can be depreciated to zero salvage value over 5 years. The lease offer it has is $1,800,000 per year for 5 years with each payment made at the BEGINNING of the year. The lessee is a subsidiary of United Equipment Corp. which borrows at 6% and has a tax rate of 40%. Your tasks: 1 Please build the model in Q5 for Greenville Electric Corp. to compare buying to leasing the equipment. 2 Based on your model, is it more profitable for Greenville Electric Corp. to lease or to buy the equipment? Asset cost Bank loan rate Lease rental payment Depreciation Tax rate Year After-tax cash flow from leasing After-tax rental After-tax cash flows from buying the asset Asset Cost Depreciation tax shield Net cash from buying Diff Cash Flow (Leasing as a loan) Lease minus buy Decision Making After-tax borrowing rate 10,000,000 6% 1,800,000 2,000,000 0% 0 1 Residual value 2 0 3 4 5 6 Real borrowing rate Greenville Electric Corp. is a public utility firm which pays no taxes. Its credit rating is Aaa, guaranteed by the city of Greenville. And thus, its loan borrowing rate is 6%. Greenville Electric has decided that it needs a new equipment. Greenville can either lease or buy the equipment. The equipment costs $10,000,000 and can be depreciated to zero salvage value over 5 years. The lease offer it has is $1,800,000 per year for 5 years with each payment made at the BEGINNING of the year. The lessee is a subsidiary of United Equipment Corp. which borrows at 6% and has a tax rate of 40%. Your tasks: 1 Please build the model in Q5 for Greenville Electric Corp. to compare buying to leasing the equipment. 2 Based on your model, is it more profitable for Greenville Electric Corp. to lease or to buy the equipment? Asset cost Bank loan rate Lease rental payment Depreciation Tax rate Year After-tax cash flow from leasing After-tax rental After-tax cash flows from buying the asset Asset Cost Depreciation tax shield Net cash from buying Diff Cash Flow (Leasing as a loan) Lease minus buy Decision Making After-tax borrowing rate 10,000,000 6% 1,800,000 2,000,000 0% 0 1 Residual value 2 0 3 4 5 6 Real borrowing rate

Answer rating: 100% (QA)

To determine whether it is more profitable to lease or buy the equipment we need to calcul... View the full answer