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##### Financial Management [21]

0
Net Cash Flow after Tax \$39,050

Terminal Cash Flow (Year 4)
Free cash flow for year 10 \$39,050
Salvage value 10,000
tax effect of capital gain (\$10,000×30%) (3,000)
Terminal cash flow \$46,050
NPV = Differential Cash flow (DCF) (PVIFAi, n) + Terminal Cash flow (TCF) (PVIFi, n) – Initial Outlay (IO)
Therefore, NPV = \$39,050 (PVIFA15%, 3) + \$46,050(PVIF15%, 4) – \$110,000
= \$89,151.15 + \$26,340.6 – \$110,000
= \$5,491.75
According to the NPV calculated above, since the NPV is \$5,491.75 and positive, so David should invest in the machine.

ii) The below table is showing the Net Advantage of Leasing
Year 0 (\$) Year 1-3 (\$) Year 4 (\$)
Proceeds of lease 110,000
Lease payment (35,000) (35,000)
Tax benefit from payment
(35,000 x 30%) 10,500 10,500
Maintenance  6,000 6,000
Maintenance tax forgone
(6,000 x 30%)  (1,800) (1,800)
Depreciation tax forgone
(110,000 / 4) x 30%  (8,250) (8,250)
Residual payment   15,000
Tax savings on the loss on sale of leased equipment
(15,000 – 10,000) x 30%   1,500
Tax payable on the sale of purchased equipment saved
10,000 x 30%   3,000
Net cash flow 85,500 (28,550) (14,550)
According to the formula, Net Advantage of Leasing (NAL) = Present value of leasing (PVL) - Present value of buying (PVB).
Where, after tax loan interest is 8.4% (12% x 70%); and PVL = \$85,500
PVB = \$28,550(PVIFA8.4%, 3) + \$14,550(PVIF8.4%, 4)
= \$73,048.03 + \$10,537.11
= \$83,585.14
Therefore, NAL = \$85,500 - \$83,585.14 = \$1,914.86
Based on the NAL calculated, because the NAL is \$ \$1,914.86 and is positive, so its better for him to lease the machine rather than buying it.
Case Study
Question 1
Depreciation Schedule
Year Depn. Allowance Depn. Expense End-of-Year Book Value
1 20% \$17,000 \$68,000
2 32% \$27,200 \$40,800
3 19% \$16,150 \$24,650
4 12% \$10,200 \$14,450
5 11% \$9,350 \$5,100
6 6% \$5,100 \$0

Year 0 (\$) Year 1 (\$) Year 2 (\$) Year 3 (\$) Year 4 (\$) Year 5 (\$) Year 6 (\$) Year 7 (\$) Year 8 (\$)
Net investment outlay
Price 80,000
Installation 5,000
Revenues  25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000
Depreciation  17,000 27,200 16,150 10,200 9,350 5,100 - -
Before-tax income  8,000 (2,200) 8,850 14,800 15,650 19,900 25,000 25,000
Tax  3,200 (880) 3,540 5,920 6,260 7,960 (10,000) (10,000)
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