Case 5 - Lease Analysis Environmental Sciences, Inc. Over...

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5 Lease Analysis Environmental Sciences, Inc. Over the past few years, officials in Florida and other states that rely primarily on deep wells for drinking water have become aware of a potentially serious problem-the pollution of aquifers by the unrestrained use of fertilizers and pesticides. The results of a study conducted by the United States Geological Survey showed that while the primary aquifer underlying Florida is not yet contaminated, one chemical commonly found in agricultural pesticides has caused extensive contamination of wells that tap water-bearing strata near the surface. To combat this potentially widespread problem, officials in Florida and elsewhere are lobbying for strict environmental regulation of commercial fertilizers and pesticides. As a result, companies specializing in agricultural chemicals have been working furiously to supply new products that will not be banned under the proposed regulations. Environmental Sciences, Inc., a regional producer of agricultural chemicals based in Orlando, recently developed a pesticide that meets the new regulations. Now the firm must acquire the necessary equipment to begin production. The estimated internal rate of return (IRR) of this project is 24 percent and the project is judged to have low risk. Environmental Sciences uses an after-tax cost of capital of 11 percent for relatively low- risk projects, 13 percent for those of average risk, and 15 percent for high-risk projects; so this low-risk project passed the hurdle rate with flying colors. The production-line equipment has an invoice price of $1,500,000, including delivery and installation charges. It falls into the modified accelerated cost recovery system (MACRS) five-year class, with current allowances of 0.20, 0.32, 0.19, 0.12, 0.11, and 0.06 in Years 1-6, respectively. Environmental's effective tax rate is 40 percent. The manufacturer of the equipment will provide a contract for maintenance and service for $80,000 per year, payable at the beginning of each year if Environmental Sciences buys the equipment. Regardless of whether the equipment is purchased or leased, Susan Baker, the firm's financial manager, does not think it will be used for more than four years, at which time Environmental's current building lease will expire. Land on which to construct a larger facility has already been acquired, and the building should be ready for occupancy at that time. The new facility will be designed to enable Environmental to use several new production processes that are currently unavailable to it, including one that will duplicate all processes of the
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Case 5 - Lease Analysis Environmental Sciences, Inc. Over...

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