Time to Fly Company needs to expand its facilities

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Time to Fly Company needs to expand its facilities. To do so, the firm must acquire a machine costing $80,000. The machine can be leased or purchased. The firm is in the 25% tax bracket, and its after-tax cost of debt is 9%. The terms of the lease and purchase plans are as follows:

Lease. The leasing arrangement requires end-of-year payments of $19,800 over 5 years. All maintenance costs will be paid by the lessor; insurance and other costs will be borne by the lessee. The lessee will exercise its option to purchase the asset for $24,000 at the termination of the lease.

Purchase. If the firm purchases the machine, its cost of $80,000 will be financed with a 5-year, 10% loan requiring equal end-of-year payments. The machine will be depreciated under MACRS using a 5-year recovery period (depreciation rates of 20%, 32%, 19%, 12%, and 12%, respectively). The firm will pay $2,000 per year for a service contract that covers all maintenance costs; insurance and other costs will be borne by the firm. The firm plans to keep the equipment and use it beyond its 5-year recovery period. (Hint: solve for the annual end-of-year loan payment first.)

 

Could you please use the chart below for the calculations. Thank you!

 

1. Determine After-Tax Cash Outflows for Lease and Purchase

Lease

After-tax cash outflows = Annual Lease*(1- tax rate) = x/year for 5 years plus purchase option amount in year 5 (year 5 totals the annual loan payment plus the purchase option amount).

Purchase

Year	Loan Payment (1)	Maintenance (2)	Depreciation (3)	Interest at x% (4)	Total Deductions (2 + 3 + 4) (5)	Tax Shields [(Tax rate) ´(5)] (6)	After-Tax Cash Outflows [(1 + 2) - (6)] (7)
1
2
3
4
5

1. Present Value of Cash Outflows Analysis

End of Year	Lease After-Tax Cash Outflows	Purchase After-Tax Cash Outflows
1
2
3
4
5
Present value of cash outflows at x% discount rate

1. Select alternative and explain why.