(answered) – 1) Craxton Engineering will either purchase or lease a newDescriptionSolution downloadThe QuestionI have a question on my homework assignment I did it in word but do not know how to put the formulas into excel so it looks like I did it in excel. I need help with this and I would appreciate help. I figured it out but it did not work the way it needs to be I did all the calculuations can you see if its right?thanks1) Craxton Engineering will either purchase or lease a new $756,000 fabricator. If purchased, the fabricator will be depreciated on a straight-line basis over 7 years. Craxton can lease the fabricator for $130,000per year for 7 years. Craxton?s tax rate is 35%. (Assume the fabricator has no residual value at the end ofthe 7 years.)a. What are the free cash flow consequences of buying the fabricator if the lease is a true tax lease?Answer:FCF0= Capital Expenditure = $756,000FCF1-7= Depreciation tax shield = 35% ? 756,000/7 = $37,800b. What are the free cash flow consequences of leasing the fabricator if the lease is a true tax lease?Answer:FCF0-6= After-tax lease payment = 130,000 ? (1 ? 35%) = $84,500c. What are the incremental free cash flows of leasing versus buying?Answer:FCF0= ?84,500 ? (?756,000) = $671,500FCF1-6= ?84,500 ? (37,800) = $122,300FCF7= 0 ? (37,800) = $37,8002) Riverton Mining plans to purchase or lease $220,000 worth of excavation equipment. If purchased,the equipment will be depreciated on a straight-line basis over 5 years, after which it will be worthless. Ifleased, the annual lease payments will be $55,000 per year for 5 years.Assume Riverton?s borrowing cost is 8%, its tax rate is 35%, and the lease qualifies as a true tax lease.a. If Riverton purchases the equipment, what is the amount of the lease-equivalent loan?Answer:If Riverton purchases the equipment it will incur depreciation of $44,000 each year($220,000/5) which would result in a tax shield of $15,400 ($44,000*35%) per yearfor five years. If Riverton leases, its lease payment would be $35,750 net oftaxes[$55,000*(1 ? 0.35)]. The free cash flows (FCF) of leasing compared to buyingis as follows:YearLeasingBuyingFCF012345(35,750) (35,750) (35,750) (35,750) (35,750)(220,000)184,25015,40015,40015,40015,40015,400(51,150) (51,150) (51,150) (51,150) (15,400)Riverton?s after-tax cost of debt is 5.2% [8%*(1 ? 0.35)]. The amount of the lease equivalent loas is thepresent value of the FCF in years 1-5 discounted at the cost of debt of 5.2%.b. Is Riverton better off leasing the equipment or financing the purchase using the lease equivalent loan?Answer:If Riverton leases, it pays $35,750 after-tax as an initial lease payment. If it buys using the leaseequivalent loan, it pays 220,000 ? 192,488 = $27,512 immediately. Buying with thelease equivalent loan is cheaper by 35,750 ? 27,512 = $8,238, since the future payments are the same anyway. Therefore Riverton is better off financing the purchaseusing the lease equivalent loan.c. What is the effective after-tax lease borrowing rate? How does this compare toRiverton?s actual after-tax borrowing rate?Answer:The effective after-tax lease borrowing rate is the internal rate of return (IRR) of theincremental FCF calculated in (a). Using Excel, the IRR is 7.0%, which is higher thanRiverton?s actual after-tax cost of debt of 5.2% [8% ? (1 ? 0.35)]. Thus, the lease isnot attractive.
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