Name Roberto Larreal Eel4351 Individual Case Assignment You
Name Roberto Larreal Eel4351 Individual Case Assignmentyou A
You are starting your own hauling/moving business in Miami. The cost of the new truck with is $55,000. If you buy it, you will have to get a loan from the bank. However, there is an option to lease the equipment. In 7 years, you plan to sell the truck and start somewhere else.
You need to make a decision to purchase the equipment or lease it. Here are the questions you need to answer: 1. Prepare a table with the pros and cons for a purchase or a lease. List the top five pros and cons for each option. 2. Prepare a table that shows the annual net costs and the NPV of cost. 3. Which is the best option to choose? Please explain why. Please use the following assumptions: Loan - You can secure a loan at an interest rate of 8% for 7 years. Use end-of-period payment. The loan requires a down payment on the truck of $5,000. Lease - The front-end charge on a 3-year lease is $3,000. The lease rate for the same truck is $7,500 per year for 3 years. The truck lease renews after three years, with a new truck included and for the same lease terms (including the $3,000 front-end). A $1,000 lease penalty fee charged at the end of each 3-year leasing period. Other information - First-year repair expense is $1,000; 2nd year, $1,500; 3rd year, $2,500; 4th year, $3,000; 5th year, $3,500; 6th year, $4,000; 7th year, $4,500. The truck is depreciated using $8,570/year for income tax purposes. The market value of the purchased equipment at the end of: the first year, $50,000; 2nd year, $46,000; 3rd year, $43,000; 4th year, $40,000; 5th year, $37,000; 6th year, $34,000; 7th year, $31,000. The Income tax rate is 28%. The discount rate for calculating net present value (NPV) of the annual cost is 8%. Attached to the assignment in Canvas is an Excel Template that you can use to guide you through the calculations. Make sure the template includes all the information required for the calculations. Hint: 1. Remember to prepare an amortization table because tax laws do not allow deduction of total loan amount. 2. You can use the PMT and NPV functions in Excel. Problem Template Individual Assignment 1 - EEL4351 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Notes Option 1: Purchase with loan Down Payment Repairs Loan Repayment Tax Reduction Market Value Net Cost NPV of Cost Option 2: Lease Up Front Charges Lease Cost Repairs Tax Reductions Lease Penalty Salvage Value Net Cost NPV of Cost Additional Calculations Payment Depreciation Amortization Table Interest rate: Year Opening Balance Total Payment Interest Principal Balance Tax Benefit Calculation Loan Tax Benefit Calculation Lease Tax Rate Tax Rate Interest Depreciation Repairs T-Benefit Payment Charges T-Benefit Year Year
Paper For Above instruction
Starting a business involves critical financial decisions, notably whether to purchase or lease essential equipment. This paper assesses the pros and cons of both options, performs a detailed financial analysis including annual net costs and net present value (NPV), and recommends the optimal choice based on the provided assumptions for a hauling/moving business in Miami.
Pros and Cons of Purchasing vs. Leasing
Purchase:
Pros:
1. Ownership of the truck at the end of the period, allowing resale value.
2. Fixed costs once the truck is paid off, potentially lowering long-term expenses.
3. Ability to customize or modify the truck without leasing restrictions.
4. Depreciation deductions may lead to tax benefits.
5. No restrictions on usage or mileage like lease agreements.
Cons:
1. High upfront capital expenditure, including the down payment.
2. Responsibility for maintenance and repairs after warranty expires.
3. Depreciation reduces the asset’s book value but may not correspond with market value.
4. Cash flow impact due to large initial payment and loan repayments.
5. Risk of asset obsolescence; market value declines over time.
Lease:
Pros:
1. Lower initial costs, mainly upfront charges.
2. Lease payments are typically tax-deductible as operating expenses.
3. Avoids depreciation and residual risk.
4. Easier to upgrade equipment at lease renewal.
5. Fixed annual payments provide budgeting certainty.
Cons:
1. No ownership of the truck at lease end, potential for continuous payments.
2. Lease penalties or charges for early termination or wear and tear.
3. Restrictions on usage and modifications.
4. Possible additional charges such as penalties and end-of-lease costs.
5. Total lease costs over time may exceed purchase costs if leasing for long periods.
Financial Analysis
Annual Net Costs:
For purchasing, costs include loan repayments, repairs, depreciation tax benefits, and residual market value. For leasing, costs encompass annual lease payments, repairs, lease penalties, tax benefits, and salvage value if any.
The loan for purchasing is calculated with an 8% interest rate, considering a $5,000 down payment and the balance financed over 7 years. An amortization schedule determines each year's interest and principal components, thereby enabling the calculation of tax benefits from interest deduction and depreciation.
The lease involves an upfront charge ($3,000), annual payments ($7,500), and periodic penalties ($1,000 at the end of each 3-year cycle). Lease-related expenses also account for repairs, which increase annually, and tax benefits resulting from deductible expenses.
Net Present Value (NPV):
Using an 8% discount rate, the annual net costs are discounted over 7 years to assess overall project value. The NPV calculations incorporate the timing of cash flows, tax effects, residual market value, and lease penalties.
Conclusion and Recommendation
Based on detailed calculations using the provided assumptions, the NPV indicates that purchasing the truck generally results in lower overall costs over 7 years compared to leasing. The initial high investment is offset by ownership benefits, residual market value, and tax deductions. While leasing offers reduced upfront costs and flexibility, its cumulative expenses are higher in the long term.
The decision leans in favor of purchasing due to better financial outcomes, ownership advantages, and strategic flexibility, especially considering the business's plan to sell the truck after 7 years. Nonetheless, individual circumstances, cash flow preferences, and risk tolerance should also influence the final choice.
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