文档搜索 > IFM7 Chapter 18

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Ch
18-06 Build a Model |
03/07/2003 |
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Chapter
18. Ch 18-06 Build a Model |
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6 |
As
part of its overall plant modernization and cost reduction program,
Western Fabrics' management has |
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7 |
decided
to install a new automated weaving loom. In the capital budgeting
analysis of this equipment, the IRR of the project |
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8 |
was
found to be 20% versus a project required return of 12%. |
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9 |
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10 |
The
loom has an invoice price of $250,000, including delivery and installation
charges. The funds needed could be |
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11 |
borrowed
from the bank through a 4-year amortized loan at a 10% interest rate,
with payments to be made at the end of |
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12 |
each
year. In the event that the loom is purchased, the manufacturer
will contract to maintain and service it for a fee of |
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13 |
$20,000
per year paid at the end of each year. The loom falls in the MACRS
5-year class, and Western's marginal |
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14 |
federal-plus-state
tax rate is 40%. |
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15 |
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16 |
Gardial
Automation Inc., maker of the loom, has offered to lease the loom to
Westen for $70,000 upon delivery and |
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17 |
installation
(at t=0) plus 4 additional annual lease payments of $70,000 to be made
at the ends of Years 1 through 4. (Note |
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18 |
that
there are 5 lease payments in total.) The lease agreement includes
maintenance and servicing. Actually, the loom |
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19 |
has
an expected life of eight years, at which time its expected salvage
value is zero; however, after 4 years, its market |
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20 |
value
is expected to equal its book value of $42,500. Tanner-Woods plans
to build and entirely new plant in 4 years, so |
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21 |
it
has no interest in either leasing or owning the proposed loom for more
than that period. |
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22 |
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23 |
a.
Should the loom be leased or purchased? |
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24 |
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25 |
First,
we want to lay out all of the input data in the problem. |
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26 |
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27 |
INPUT
DATA |
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28 |
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29 |
Invoice
Price |
$250,000 |
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30 |
Length
of loan |
4 |
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31 |
Loan
Interest rate |
10% |
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32 |
Maintenance
fee |
$20,000 |
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33 |
Tax
Rate |
40% |
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34 |
Lease
fee |
$70,000 |
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35 |
Equipment
expected life |
8 |
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36 |
Expected
salvage value |
$0 |
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37 |
Market
value after 4 years |
$42,500 |
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38 |
Book
value after 4 years |
$42,500 |
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39 |
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40 |
First,
we can determine the annual loan payment that must be made on the new
equipment. We will do so using the |
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41 |
function
wizard for PMT. |
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42 |
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43 |
Annual
loan payment = |
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44 |
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45 |
Year |
1 |
2 |
3 |
4 |
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46 |
Beginning
loan balance |
$250,000 |
$275,000 |
$302,500 |
$332,750 |
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47 |
Interest
payment |
$25,000 |
$27,500 |
$30,250 |
$33,275 |
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48 |
Principal
payment |
($25,000) |
($27,500) |
($30,250) |
($33,275) |
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49 |
Ending
loan balance |
$275,000 |
$302,500 |
$332,750 |
$366,025 |
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50 |
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51 |
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52 |
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53 |
Now,
we see that the decision being made is whether to purchase the equipment
at a net cost of $250,000 (with annual |
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54 |
payments
of $78,868) or lease the equipment and make annual payments of $70,000.
To make this decision, we must |
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55 |
analyze
the incremental cash flows. |
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56 |
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57 |
Before
proceeding with our NPV analysis we must determine the schedule of depreciation
charges for this new |
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58 |
equipment. |
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59 |
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60 |
MACRS
5-year Depreciation Schedule |
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61 |
Year |
1 |
2 |
3 |
4 |
5 |
6 |
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62 |
Depr.
Rate |
20% |
32% |
19% |
12% |
11% |
6% |
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63 |
Depr.
Exp. |
$50,000 |
$80,000 |
$47,500 |
$30,000 |
$27,500 |
$15,000 |
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64 |
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65 |
We
can now construct our table of incremental cash flows from these two
alternatives. Remember, that the appropriate |
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66 |
discount
rate in this scenario is the after tax cost of borrowing, or:
10%*(1-40%) = 6%. |
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67 |
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68 |
NPV
LEASE ANALYSIS OF INCREMENTAL CASH FLOWS |
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69 |
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70 |
Year
= |
0 |
1 |
2 |
3 |
4 |
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71 |
Cost of ownership |
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72 |
Purchase
cost |
($250,000) |
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73 |
Loan
proceeds |
$250,000 |
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74 |
After-tax
interest payment |
($15,000) |
($16,500) |
($18,150) |
($19,965) |
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75 |
Principal
payment |
$25,000 |
$27,500 |
$30,250 |
$33,275 |
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76 |
Maintenance
cost |
($20,000) |
($20,000) |
($20,000) |
($20,000) |
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77 |
Tax
savings from maintenance cost |
$8,000 |
$8,000 |
$8,000 |
$8,000 |
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78 |
Tax
savings from depreciation |
$20,000 |
$32,000 |
$19,000 |
$12,000 |
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79 |
Salvage
value |
$42,500 |
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80 |
Net
cash flow from ownership |
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81 |
PV
cost of ownership |
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82 |
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83 |
Cost of leasing |
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84 |
Lease
payment |
($70,000) |
($70,000) |
($70,000) |
($70,000) |
($70,000) |
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85 |
Tax
savings from lease payment |
$28,000 |
$28,000 |
$28,000 |
$28,000 |
$28,000 |
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86 |
Net
cash flow from leasing |
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87 |
PV
cost of leasing |
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88 |
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89 |
Cost Comparison |
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90 |
PV
ownership cost @ 6% |
$0 |
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91 |
PV
of leasing @ 6% |
$0 |
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92 |
Net
Advantage to Leasing |
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93 |
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94 |
Our
NPV Analysis has told us that there is a negative advantage to leasing.
We interpret that as an indication that the |
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95 |
firm
should forego the opportunity to lease and buy the new equipment. |
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96 |
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97 |
b.
The salvage value is clearly the most uncertain cash flow in the analysis.
Assume that the appropriate salvage value |
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98 |
pre-tax discount rate is 15 percent. What would be the effect
of a salvage value risk adjustment on the decision? |
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99 |
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100 |
All
cash flows would remain unchanged except that of the salvage value.
Our new array of cash flows would resemble the |
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101 |
following: |
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102 |
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103 |
Standard
discount rate |
10% |
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104 |
Salvage
value rate |
15% |
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105 |
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106 |
Year
= |
0 |
1 |
2 |
3 |
4 |
4 |
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107 |
Net
cash flow |
$0 |
$0 |
$0 |
$0 |
$13,310 |
$42,500 |
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108 |
PV
of net cash flows |
$0 |
$0 |
$0 |
$0 |
$10,543 |
$30,108 |
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109 |
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110 |
NPV
of ownership |
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111 |
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112 |
New Cost Comparison |
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113 |
PV
ownership cost @ 6% |
$0 |
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114 |
PV
of leasing @ 6% |
$0 |
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115 |
Net
Advantage to Leasing |
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116 |
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117 |
Under
this new assumption of using a greater discount factor for the salvage
value, we find that the firm should lease, and |
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118 |
not
buy, the equipment. |
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119 |
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120 |
c.
Assuming that the after-tax cost of debt should be used to discount
all anticipated cash flows, at what lease payment |
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121 |
would the firm be indifferent to either leasing or buying? |
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122 |
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123 |
We
will use the Goal Seek function to determine the lease payment that
makes the Net Advantage to Leasing zero. |
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124 |
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125 |
Crossover
= |
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126 |
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127 |
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128 |
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129 |
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130 |
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131 |
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132 |
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133 |
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134 |

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