Start with the partial model in the file Ch 18 P06 Build a Model xls on the textbook's web site. As part of its overall plant modernization and cost reduction program, Western Fabric's management has decided to install a new automated weaving loom. In the capital budgeting analysis of this equipment, the IRRof the project was found to be 20% versus the project's required return of 12%.

The loom has an invoice price of $250,000, including delivery and installation charges. The funds needed could be borrowed from a bank through a 4 year amortized loan at a 10% interest rate, with payments to be made at the end of each year. In the event the loom is purchased, the manufacturer will contract to maintain and service it for fee of $20,000 per year paid at the end of each year. The loom falls in the MACRS 5 year class, and Western's marginal federal plus state tax rate is 40%.

Aubrey Automation Inc., maker of the loom, has offered to lease the loom to Western for $70,000 upon delivery and installation (at t=0) plus four additional annual lease payments of $70,000 to be made at the end of years 1 to 4. (Note that there are five lease payments total) The lease agreement includes maintenance and servicing. Actually, the loom has ana expected life of 8 years, at which time its expected salvage value is zero; however after 4 years its market value is expected to equal its book value of $42,500. Western plans to build an entirely new plant in 4 years, so it has no interest in either leasing or owning the proposed loom for more than that period.

a. Should the loom be leased or purchased

I don't understand how to figure the PV cost of ownership and PV cost of Leasing. Is there a specific equation to figure these? This is what I have been able to put together so far.

	Year =		0	1	2	3	4
Cost of ownership
Purchase cost			($250,000)
Loan proceeds			$250,000
After-tax interest payment				($15,000)	($16,120)	($17,351)	($18,706)
Principal payment				$18,659	$20,525	$22,578	$24,836
Maintenance cost				($20,000)	($20,000)	($20,000)	($20,000)
Tax savings from maintenance cost				$8,000	$8,000	$8,000	$8,000
Tax savings from depreciation				$20,000	$32,000	$19,000	$12,000
Salvage value							$42,500
Net cash flow from ownership			$0	$11,659	$24,406	$12,227	$48,630
PV cost of ownership
Cost of leasing
Lease payment			($70,000)	($70,000)	($70,000)	($70,000)	($70,000)
Tax savings from lease payment			$28,000	$28,000	$28,000	$28,000	$28,000
Net cash flow from leasing			($42,000)	($42,000)	($42,000)	($42,000)	($42,000)
PV cost of leasing
Cost Comparison
PV ownership cost @ 6%		$0
PV of leasing @ 6%		$0
Net Advantage to Leasing