Delmont Transport Company DTC is evaluating the merits of le

Delmont Transport Company (DTC) is evaluating the merits of leasing versus purchasing a truck with a 4-year life that costs $40,000 and falls into the MACRS 3-year class. If the firm borrows and buys the truck, the loan rate would be 10%, and the loan would be amortized over the truck\'s 4-year life, so the interest expense for taxes would decline over time. The loan payments would be made at the end of each year. The truck will be used for 4 years, at the end of which time, it will be sold at an estimated residual value of $10,000. If DTC buys the truck, it would purchase a maintenance contract that costs $1,000 per year, payable at the end of each year. The lease terms, which include maintenance, call for a $10,000 lease payment at the beginning of each year (i.e. 4 payments total). DTC\'s tax rate is 40%.

What is the net advantage to leasing?

           (Note: Assume MACRS rates for Years 1 to 4 are 0.3333, 0.4445, 0.1481, and 0.0741.)

Please show work and charts. Thank you

Solution

cost of purchase Formulas year principle payments interest payments taxes on interest pay ments Depreciation taxes on depreciation maintenance resale cost principle payments interest payments 1 ($8,618.83) ($4,000.00) ($1,600.00) 13200 5280 1000 ($6,738.83) PPMT(0.1,1,4,40000) IPMT(0.1,1,4,40000) 2 ($9,480.72) ($3,138.12) ($1,255.25) 18000 7200 1000 ($5,163.59) 3 ($10,428.79) ($2,190.05) ($876.02) 6000 2400 1000 ($10,342.81) 4 ($11,471.67) ($1,147.17) ($458.87) 2800 1120 1000 10000 ($2,039.97) Total ($40,000.00) ($10,475.33) ($4,190.13) 40000 16000 4000 10000 ($24,285.20) PV of cost of purchase = ($16,587.12) PV(0.1,4,,24285.2) cost of lease 10000 *4 = 40000 less: taxes on lease 16000 (0.4*400000) = 24000 PV of lease ($16,392.32) PV(0.1,4,,24000) Adv of lease = PV of purchase - PV of lease 194.8 There fore Delmont should lease the truck