For problems #1, #2, and #3, I do not understand how each of these answers was arrived at in the

answer chart for each problem. For problem #4, I am using the information from the categories in the
previous problems but am unable to calculate the values for each category. Can you provide a full
explanation of how each figure for each category was arrived at?
1) Big Sky Mining Company must install $1.5 million of new machinery in its Nevada mine. It can
obtain a bank loan for 100% of the purchase price, or it can lease the machinery. Assume that the
following facts apply:
1. The machinery falls into the MACRS 3-year class.
2. Under either the lease or the purchase, Big Sky must pay for insurance, property taxes, and
maintenance.
3. The firm's tax rate is 40%. 
4. The loan would have an interest rate of 15%.
5. The lease terms call for $400,000 payments at the end of each of the next 4 years. 
6. Big Sky Mining has no use for the machine beyond the expiration of the lease, and the machine has
an estimated residual value of $250,000 at the end of the 4th year. 
What is the NAL (Net Advantage of Leasing) of the lease?

You would have cash flows for owning and leasing in years 1-4.  You should also have tax on residual
value in year 4 in cost of owning.

NPV LEASE ANALYSIS

Year = 0 1 2 3 4
    Cost of Owning
After-tax loan payments ($135,000) ($135,000) ($135,000) ($1,635,000)
Maintenance Cost
Tax savings from main.
Tax savings from depr. $198,000 $270,000 $90,000 $42,000
Residual value $250,000
Tax on residual value         ($100,000)
Net cash flow $0 $63,000 $135,000 ($45,000) ($1,443,000)
 $
PV ownership cost @ 9%
(885,580.87)

   Cost of Leasing
Lease payment(AT)   ($240,000) ($240,000) ($240,000) ($240,000)
Net cash flow $0 ($240,000) ($240,000) ($240,000) ($240,000)
 $
PV of leasing @ 6.5%
(777,532.77)

   Cost Comparison
 $
PV ownership cost @ 9%
(885,580.87)
 $
PV of leasing @9%
(777,532.77)
Net Advantage to Leasing  $   108,048.10

2) Net advantage to leasing problem (NAL).

ABC Industries is negotiating a lease on a new piece of equipment which would cost $100,000 if
purchased. The equipment falls into the MACRS 3-year class, and it would be used for three years and
then sold, because ABC plans to move to a new facility at that time. It is estimated that the equipment
could be sold for $30,000 after three years of use. A maintenance contract on the equipment would cost
$3,000 per year, payable at the beginning of each of the three years of usage. Conversely, ABC could
lease the equipment for three years for a lease payment of $29,000 per year, payable at the beginning of
each year. The lease would also include maintenance. ABC is in the 20 percent tax bracket, and it could
obtain a three-year simple interest loan to purchase the equipment at a before tax cost of 10 percent.
Should ABC lease or buy?

NPV LEASE ANALYSIS

Year = 0 1 2 3

    Cost of Owning

After-tax loan payments ($8,000) ($8,000) ($108,000)

Maintenance Cost (after

($2,400) ($2,400) ($2,400) $0
tax)

Depreciation $33,000 $45,000 $15,000

Tax savings from depr. $6,600 $9,000 $3,000

Residual value $30,000

Tax on residual value       ($4,600)

Net cash flow ($2,400) ($3,800) ($1,400) ($79,600)

 $
PV ownership cost @ 8%
(70,307.84)

   Cost of Leasing

Lease payment $29,000 $29,000 $29,000 $0

Tax savings from lease ($5,800) ($5,800) ($5,800) $0

Net cash flow $23,200 $23,200 $23,200 $0

PV of leasing @ 8%  $  64,571.74

   Cost Comparison

PV ownership cost @ 8%  $ (70,307.84)

PV of leasing @ 8%  $  64,571.74

Net Advantage to Leasing  $   (5,736.10)

3) Walton Publishing Company (WPC) is evaluating a potential lease agreement on a printing press that
costs $250,000 and falls into the MACRS 3-year class. The firm can borrow at an 8 percent rate on a 4-
year amortized loan, if WPC decides to borrow and buy rather than lease. The press has a 4-year
economic life, and its estimated residual value is $25,000 at the end of year 4. If WPC buys the press, it
would purchase a maintenance contract that costs $5,000 per year, payable at the beginning of each
year. The lease terms which include maintenance call for a $71,000 lease payment at the beginning of
each year. WPC's tax rate is 40 percent. Should the firm lease or buy?

Answer: They should buy because the PV is about 2,400 less. (Not sure if this is conclusion is correct or
the chart analysis below is correct)

YEAR 0 1 2 3 4
Buy
Loan -250,000.00
depreciation -82,500.00 -112,500.00 -37,500.00 -17,500.00
tax savings 33,000.00 45,000.00 15,000.00 7,000.00
at maintenance -5,000.00 -5,000.00 -5,000.00 -5,000.00 0.00
residual value 25,000.00
free cash flow buy -250,000.00 28,000.00 40,000.00 10,000.00 32,000.00
PV(loan) -255,000.00 26,717.56 36,419.79 8,687.93 26,528.02 -156,646.71
After tax borrowing =.6*.08=4.8%

Lease payments 71,000.00 71,000.00 71,000.00 71,000.00

tax savings -28,400.00 -28,400.00 -28,400.00 -28,400.00 0.00
cash flow lease 42,600.00 42,600.00 42,600.00 42,600.00 0.00
PV(lease) 42,600.00 40,648.85 38,787.08 37,010.57 0.00 159,046.50

lease vs. loan 2,399.79

4) Treadmill Trucking Company is negotiating a lease for five new tractor/trailer rigs with Leasing
International. Treadmill has received its best offer from Betterbilt Trucks for a total price of $1 million.
The terms of the lease offered by International Leasing call for a payment of $205,000 at the beginning
of each year of the 5-year lease. As an alternative to leasing, the firm can borrow from a large insurance
company and buy the trucks. The $1 million would be borrowed on a simple interest loan at a 10
percent interest rate for 5 years. The trucks fall into the MACRS 5-year class and have an expected
residual value of $100,000. Maintenance costs would be included in the lease. If the trucks were owned,
a maintenance contract would be purchased at the beginning of each year for $10,000 per year.
Treadmill plans to buy a new fleet of trucks at the end of the fifth year. Leasing International has a 40
percent federal-plus-state marginal tax rate, while Treadmill Trucking has a total tax rate of 20 percent.
What is Treadmill's present value of the cost of owning? What is Treadmill's present value of the cost of
leasing? Should Treadmill lease?