Determine the firms cash inflows and outflows

Question

Problem: A firm wants the use of a machine that cost $100,000. If the firm purchases the equipment, it will depreciate the equipment at the rate of $20,000 a year for four years, at which time the equipment will have a residual value of $20,000. Maintenance will be $2,500 a year. The firm could lease the equipment for four years for an annual lease payment of $26,342. Currently, the firm is in the 40 percent income tax bracket.

Q1. Determine the firm's cash inflows and outflows from purchasing the equipment and from leasing.

Q2. If the firm uses a 14 percent cost of funds to analyze decisions that involve payments over more than a year, should management lease the equipment or purchase it?

Q3. Would your answer differ if the cost of funds were 8 percent?

Buy
	0	1	2	3	4
Equipment Cost	(100,000.00)
Maintenance		(2,500.00)	(2,500.00)	(2,500.00)	(2,500.00)
Maintenance tax savings		1,000.00	1,000.00	1,000.00	1,000.00	This is 40% ( tax rate)
Depreciation Shield		8,000.00	8,000.00	8,000.00	8,000.00	This is depreciation * tax rate
Residual Value					20,000.00
RV Tax					(8,000.00)
Net Owning CF	(100,000.00)	6,500.00	6,500.00	6,500.00	18,500.00
PV Factor @ 14%	1.00	0.877	0.769	0.675	0.592
DCF	(100,000.00)	5,701.75	5,001.54	4,387.31	10,953.49
NPV	(73,955.91)
Lease
Lease Payment		(26,342.00)	(26,342.00)	(26,342.00)	(26,342.00)
Tax Savings		10,536.80	10,536.80	10,536.80	10,536.80
Net Leasing CF		(15,805.20)	(15,805.20)	(15,805.20)	(15,805.20)
PV Factor @14%		0.877	0.769	0.675	0.592
DCF		(13,864.21)	(12,161.59)	(10,668.06)	(9,357.95)
PV	(46,051.81)
At 8%
Buy
	0	1	2	3	4
Equipment Cost	(100,000.00)
Maintenance		(2,500.00)	(2,500.00)	(2,500.00)	(2,500.00)
Maintenance tax savings		1,000.00	1,000.00	1,000.00	1,000.00
Depreciation Shield		8,000.00	8,000.00	8,000.00	8,000.00
Residual Value					20,000.00
Residual Value Tax					(8,000.00)
Net Owning CF	(100,000.00)	6,500.00	6,500.00	6,500.00	18,500.00
PV Factor @ 8%	1.00	0.926	0.857	0.794	0.735
DCF	(100,000.00)	6,018.52	5,572.70	5,159.91	13,598.05
NPV	(69,650.82)
Lease
Lease Payment		(26,342.00)	(26,342.00)	(26,342.00)	(26,342.00)
Tax Savings		10,536.80	10,536.80	10,536.80	10,536.80
Net Leasing CF		(15,805.20)	(15,805.20)	(15,805.20)	(15,805.20)
PV Factor @8%		0.926	0.857	0.794	0.735
DCF		(14,634.44)	(13,550.41)	(12,546.68)	(11,617.29)
PV	(52,348.83)