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9/2/2006 Chapter 20. Solution to Ch 20-06 Build a Model a. Should the loom be leased or purchased? First, we want to lay out all of the input data in the problem. INPUT DATA Invoice Price $250,000 Length of loan 4 Loan Interest rate 10% Maintenance fee $20,000 Tax Rate 40% Lease fee $70,000 Equipment expected life 8 Expected salvage value $0 Market value after 4 years $42,500 Book value after 4 years $42,500 First, we can determine the annual loan payment that must be made on the new equipment. We will do so using the function wizard for PMT. Annual loan payment = $78,868 Year 1 2 3 4 Beginning loan balance $250,000 $196,132 $136,878 $71,698 Interest payment $25,000 $19,613 $13,688 $7,170 Principal payment $53,868 $59,254 $65,180 $71,698 Ending loan balance $196,132 $136,878 $71,698 $0 As part of its overall plant modernization and cost reduction program, Western Fabrics' management has decided to install a new automated weaving loom. In the capital budgeting analysis of this equipment, the IRR of the project was found to be 20% versus the project's required return of 12%. The loom has an invoice price of $250,000, including delivery and installation charges. The funds needed could be borrowed from the bank through a 4-year amortized loan at a 10% interest rate, with payments to be made at the end of each year. In the event that the loom is purchased, the manufacturer will contract to maintain and service it for a fee of ... View Full Document
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