og mer 3 Chapter 8 -- Lease Financing 4 5 Minicase 3 7 Lewis Health System Inc. has decided to acquire a new electronic health record system for its Richmond 8 hospital. The system receives clinical data and other patient information from nursing units and other patient 9 care areas, then either displays the information on a screen or stores it for later retrieval by physicians. The 10 system also permits patients to call up their health record on Lewis's website. 1 2 The equipment costs $1,000,000, and, if it were purchased, Lewis could obtain a term loan for the full purchase 13 price at a 10 percent interest rate. Although the equipment has a six-year useful life, it is classified as a special- 14 purpose computer, so it falls into the MACRS three-year class. If the system were purchased a four-year 5 maintenance contract could be obtained at a cost of $20,000 per year, payable at the beginning of each year. 16 The equipment would be sold after four years, and the best estimate of its residual value at that time is $200,000. However, since real-time display system technology is changing rapidly, the actual residual value is 17 uncertain. 18 9 As an alternative to the borrow-and-buy plan, the equipment manufacturer informed Lewis that Consolidated 20 Leasing would be willing to write a four-year guideline lease on the equipment, including maintenance, for 21 payments of S260,000 at the beginning of each year. Lewis's marginal federal-plus-state tax rate is 30 percent. You have been asked to analyze the lease-versus-purchase decision, and in the process to answer the following 22 questions: 23 24 a. What is the present value cost of owning the equipment? 25 b. What is the present value cost of leasing the equipment? 26 c. What is the net advantage to leasing (NAL)? 27 d. Answer these questions one at a time to see the effect of the change on NAL. That is, starting with 28 the original numbers you used for questions a. and b., what is the NAL if: 29 - interest rate increases to 12 percent BO - maintenance cost increases to $25,000 per year B1 - residual value falls to $150,000 B2 - the system price increases to $1,050,000? $3 e. Do the changes in d. make leasing more or less attractive? Explain. 41 v fe A B D E F G H H MACRS Year 1 Year 2 Year 3 Year 4 33% 45% 15% 7% 0% 0% 0% SO SO SO SO Year 0 Year 1 Year 2 Year 3 Year 4 5 ANSWER 5 Pre-tax interest rate Tax rate 8 After-tax interest rate 9 Lease payment 10 System purchase price 1 Maintenance 2 Residual value 13 14 a. 5 46 Cost of owning: 47 Net purchase price 48 Maintenance cost 49 Maintenance tax savings 50 Depreciation tax savings 51 Residual value 52 Tax on residual value 53 Net cash flow 54 55 b. 56 Cost of leasing: 57 Lease payment 58 Lease tax savings 59 Net cash flow 60 61 Net advantage to leasing: 62 PV cost of leasing 63 PV cost of owning 64 NAL 65 SO SO SO SO SO SO SO SO SO SO SO SO SO SS SS 1 SO SO SO SO SO SO SO SO SS3 3188 SO SO SO SO SO SO SO 66 C Mainten COST $25,000 67 68 69 Net advantage to leasing: 70 PV cost of leasing 71 PV cost of owning 72 NAL 73 74 d. 75 Interest rate 12% $0 $0 SO 8188 Residual System value price S150,000 $1,050,000 SO SO SO se SO SO