QUESTION 2

Lee Wah Press (LWP) is considering a leasing arrangement to finance some special printing machines that it needs for production during the next three years.

A planned change in the companys production technology will make the new machine obsolete after 3 years. LWP will depreciate the new machine on a straight-line basis towards zero salvage value. The firm can borrow the installed cost of $480,000, at 10% interest per annum, calculated on an annual reducing balance, to buy the new machine or make three equal beginning-of-year lease payments of $210,000 should it decide to take up lease financing.

Annual maintenance costs associated with ownership, payable at the end of year, are estimated at $25,000. Annual insurance premium associated with the purchase is estimated to be at $6,000, payment is on a cash-before-cover basis. Should LWP opt for lease financing, all other costs will be borne by the lessor. LWP tax rate is 40%.

What is the net advantage to leasing (NAL)? Which option should LWP select, lease financing or purchase outright via bank borrowing?

a. The annual after-tax cash outflow of the lease option in Year 1, Year 2, and Year 3 is $____.

b. The present value of the after-tax cash outflows of the lease option is $____.

c. The annual loan payment amount of the purchase option in Year 1, Year 2 and Year 3 is $____.

d. The interest expense of the purchase option in Year 1 is $____.

e. The interest expense of the purchase option in Year 2 is $____.

f. The interest expense of the purchase option in Year 3 is $____.

g. The annual maintenance cost associated with the purchase option in Year 1, Year 2, and Year 3 is $____.

h. The annual insurance premium associated with the purchase option in Year 1, Year 2, and Year 3 is $____

i. The annual depreciation amount associated with the purchase option in Year 1, Year 2 and Year 3 is $____.

j. The total deduction amount for the purchase option eligible for tax shield in Year 0 is $____.

k. The total deduction amount for the purchase option eligible for tax shield in Year 1 is $____.

l. The total deduction amount for the purchase option eligible for tax shield in Year 2 is $____.

m. The total deduction amount for the purchase option eligible for tax shield in Year 3 is $____.

n. The tax shield amount in Year 0 is $____.

o. The tax shield amount in Year 1 is $____.

p. The tax shield amount in Year 2 is $____.

q. The tax shield amount in Year 3 is $____.

r. The after-tax cash outflow associated with the purchase option in Year 0 is $____.

s. The after tax cash outflow associated with the purchase option in Year 1 is $____

t. The after-tax cash outflow associated with the purchase option in Year 2 is $____.

u. The after tax cash outflow associated with the purchase option in Year 3 is $____.

v. The present value of the after-tax cash outflows of the purchase option is $____.

w. The Net Advantage of Leasing (NAL) is $____.

x. Should LWP lease or purchase the special printing machine? choose from (Purchase/Lease)