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4 pages/≈1100 words
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APA
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Accounting, Finance, SPSS
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English (U.S.)
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Topic:

Company in Business and Intending to make a Profit

Essay Instructions:

Ryan, the president of the Open Corporation, is considering leasing or purchasing equipment. Microtech Corporation has offered to sell the Open Corporation the equipment at a price of $6010,000. Following its usual practice, the equipment is depreciated over four years, at the rates of 40% for the first year, and 20% for each of the remaining three years. The salvage value of this equipment is expected to be 0.

Alternatively, the Open Corporation can lease the equipment from Scott Corporation. Four annual lease payments of $1.9 million are settled at the beginning of each year. Open Corporation can raise capital by issuing bonds with a yield of 12 percent, and the tax rate for Open Corporation is set to be 30 percent.

After comparing the above two options, the Chief Financial Officer of Open Corporation, commented, “Scott’s offer is financially unreasonable due to a negative NAL (i.e. net advantage to leasing) to our company. Therefore, the annual lease payments should be curtailed. Meanwhile, we can pay a security deposit to Scott as an incentive. This deposit would be returned on the expiration date of the lease contract.” In response to CFO’s comments, Ryan added, “If the leasing term is acceptable to us, this will suggest that a negative NAL should be brought to Scott. As far as I know, leasing is a zero-sum game between the lessee and lessor. I believe Scott reject our counter offer.” After several rounds of discussion, Ryan eventually determines to propose a counter offer to Scott, with a reduced lease payment of $1.8 million on annual basis and a security deposit of $1,000,000.

Required:

(a) In light of the NAL calculation, comment on the following remarks “Scott’s offer is financially unreasonable due to a negative NAL (i.e. net advantage to leasing) to our company.”
(12 marks)

(b) According to the counter offer by the Open Corporation, evaluate the NAL to Scott. What is the reaction of Scott to this counter offer? The tax rate for Scott is presumed to be 40%.
(14 marks)

(c) Critically discuss Ryan’s remark “leasing is a zero sum game between the lessee and lessor”.
(12 marks)

(d) Explain the rationale for lessees to accept a lease offer even if NALs are negative.
(12 marks)

(e) If the purchase of equipment is funded by bond issuance instead of own capital, do you consider this factor in NAL analysis? Explain.
(10 marks)

Essay Sample Content Preview:

Assignment
Student’s Name
Course Title
Institutional Affiliations
(a) In light of the NAL calculation, comment on the following remarks “Scott’s offer is financially unreasonable due to a negative NAL (i.e., the net advantage to leasing) to our company.”
A company may have to consider two options when acquiring new assets that are considered capital intensive. The company may opt to either buy the asset or lease depending on some factors. As a company in business and intending to make a profit, consideration is given to how the company is to benefit from leasing as opposed to purchasing. This is usually referred to as Net advantage to leasing, abbreviated as NAL.
The firm led by Ryan, for instance, may use NAL to determine the effectiveness of assets acquisition. Only after acceptable calculations can the company decide whether to lease or purchase the said asset. Another crucial aspect to factor in is the issue of timeframe ( Esposito, Tse, & Soufani, 2018). Say, for instance, the company wanted to acquire a production machine to aid in its operations. The said time frame should be based on the average lifecycle of that machine. At times there is always a need to consider Salvage value, but for purposes of answering this question, the salvage value is zero and will thus not be considered.
NAL = OWNING (PV) – LEASING (PV)
Buying the assest would consider values such as Salvage value, initial payment and the tax shield.
I =- $6 010,000Salvage value = 0 tax shield= 1,951,856
NPV (buying) = -6,010,000 +1,951,856= -4,058,144
Leasing the asset
NPV leasing
after tax lease payments= 1,900,000 1-0.3= 1,330,000PV= -4,246,722 NAL= -188, 578
If NAL<0, purchasing is more affordable
We realize that satisfies the condition of NAL<0; the company should therefore purchase the asset. In case NAL resulted in a positive value greater than zero, leasing the asset would be the affordable alternative.
According to the counteroffer by the Open Corporation, evaluate the NAL to Scott. What is the reaction of Scott to this counteroffer? The tax rate for Scott is presumed to be 40%.
NAL = less than zero. After carefully analyzing the counter offer the company would be in a position to consider purchasing the assets because this way, the money will be saved as compared to leasing it for more.
NAL=-6,010,000+4569600=-1442400
The counteroffer by Scott’s firm has a loss of 1442400
The open corporation counter offer is not working in Scott’s favor. The key to handling such a situation is to maintain professionalism in affirming his terms of the deal. Apparently, this new counter offer provides an opportunity to get a more favorable deal. Scott’s reaction to this counteroffer is to reject because the deal is not favorable. It carries a loss of 1442400.
After tax cost of debt
0.401-0.4=0.24
The net advantage to leasing is less than zero and thus it becomes more favorable to purchase the asset. Chartering the asset would be more affluent. This explains the reason why Scott needs to seek a more favorable deal.
c) Critically discuss Ryan's remark, "leasing is a zero-sum game between the lessee and lessor."
Two companies agree on leasing an a...
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