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This spreadsheet supports STUDENT analysis of the case,

"Primus Automation Division, 2002" (Case 40).


Please note:
1) This is a working model. Assumptions / Inputs presented can
be changed to vary the results.
2) As long as default spreadsheet calculation is "automatic"
the impact of changing assumptions will be computed in real
time. If calculation is set as "manual" you should press the F9
function key to recalculate results. To set numerical calculation
settings to automatic look under tools, options, calculations
menu.

Copyright 2005 by the University of Virginia Darden School Foundation.

Lessee Input Data:


1. Tax Rate
2. Pre-tax Interest Rate
3. Equipment Cost
4. Lease Payment
5. Guaranteed Residual Value
6. Cash Down Payment
7. Annual Loan Term

$
$
$

34.00%
9.50%
715,000
160,003
11.2729%
5

Results for Lessee:


1. Loan NPV
2. Lease NPV
3. Loan IRR
4. Lease IRR
5. Savings

$469,273
$469,273
6.27%
6.27%
(0)

Loan Amortization Table


Year
Beginning Balance
Annual Payment
Interest Before Tax @
Principal Reduction
Ending Balance
Tax Rate
Interest After Tax
Total Interest Paid
Total Principal Paid

$
$186,212
9.50%

1
715,000
186,212
67,925
118,287
$596,713

2
$596,713
186,212
56,688
129,524
$467,189

$44,831

$37,414

34.00%

$142,600
$715,000

n Table
3
$467,189
186,212
44,383
141,829
$325,360

4
$325,360
186,212
30,909
155,303
$170,057

5
$170,057
186,212
16,155
170,057
$0

$29,293

$20,400

$10,663

Exhibit 1
AvantJet Statement of Income
($000)
2001

2000

1999

576,327 $
9,985

575,477 $
6,976

432,522
9,677

Gross income

586,312

582,453

442,199

Cost of goods sold


Selling, general, & admin.
Research & development
Interest

425,076
43,624
13,773
84,062

423,443
36,215
12,873
87,259

325,016
35,632
9,064
27,002

566,535

559,790

396,714

19,777
9,690

22,662
11,105

45,485
22,288

10,087 $

11,557 $

23,197

Sales
Other income

Total expenses
Income before taxes
Taxes
Net income
Source: Company records.

Exhibit 2
AvantJet Balance Sheet
($000)
2001

2000

Assets
Current assets:
Cash and temporary investments
Accounts receivable
Inventories
Prepaid expenses

Total current assets


Property, plant, and equipment:
Land
Buildings
Machinery and equipment
Furniture and fixtures
Construction in progress
Less accumulated depreciation
Net property, plant, and equipment
Other assets
Total assets

19,918 $
37,791
310,180
13,928

27,263
37,307
323,101
13,362

381,817

401,033

2,245
30,654
26,932
1,683
1,668
63,182
12,634
50,548

2,245
30,229
21,244
1,520
885
56,123
8,267
47,856

640,369

648,339

1,072,734 $

1,097,228

592 $
42,355
4,750

563
38,760
5,764

Liabilities and stockholders' equity


Current liabilities:
Long-term debt
Accounts payable
Notes payable
Accrued compensation, interest,
and other liabilities
Deposits and progress payments
Total current liabilities
Long-term notes payable to banks
Deferred income taxes
Common stockholders' equity:

39,627
146,964

43,855
160,946

234,288

249,888

646,633
42,661
689,294

671,225
41,498
712,723

Common stock
Capital in excess of par value
Retained earnings
Less common stock in treasury
Total stockholders' equity
Total liabilities and stockholders' equity
Source: Company records.

3,385
74,081
72,017
(331)

3,027
69,770
62,156
(336)

149,152

134,617

1,072,734 $

1,097,228

Exhibit 3
Terms Under Hypothetical Buy-and-Borrow
and Leasing Strategies
Loan (Buy-and-Borrow)
5-year term loan
Payment in arrears
Equipment cost
Cash down payment
Loan amount
Lease
5-year net lease
Leasing option #1
Leasing option #2
Leasing option #3
Leasing option #4
Both Methods
Guaranteed residual value:
(required by Primus Equipment Finance Division)
Investment tax credit
Depreciation

y-and-Borrow
ies

$715,000
$0
$715,000
Annual payments
(in advance)
$155,040
$160,003
$162,350
$164,760
11.2729%
0%
5-year MACRS

Exhibit 4
Sample Calculation of the Present Value of Cash Outflows1
Tax rate:
Pretax interest rate:

Year
0
1
2
3
4
5
Sum
NPV

34.00%
9.50%

Equipment cost: $ 715,000


Lease payment: $ 160,003

Interest

Five-Year

Payment
after

Principal

MACRS3
Depr.

Depr.
before

Tax2

Payment2

Rate

Tax

$44,831
$37,414
$29,293
$20,400
$10,663
$142,600

$118,287
$129,524
$141,829
$155,303
$170,057
$715,000

20.00%
32.00%
19.20%
11.52%
11.52%
94.24%

$143,000
$228,800
$137,280
$82,368
$82,368
$673,816

This table illustrates the calculation of net present value (NPV) for the two methods of equipment financing: the loan fina
borrow) and the lease financing. Because these cash flows are net outflows or expenses, the alternative with the lower net
the customer.
1

See Loan Amortization Table.

Modified Accelerated Cost Recovery System (MACRS).

The residual cash flow equals the sale proceeds less the tax expense on the gain or loss from the sale. The tax expense equ
between sale proceeds and net book value of the asset (see separate calculation below).
4

Loan cash flows are the sum of after-tax interest payments, principal payments, depreciation tax shield (shown as a negativ
value captured from sale of the residual asset (also negative). Loan-financing cash flows occur in arrears.
5

Lease cash flows equal the assumed lease payment less the tax shield. Lease payments are made in advance.

Memo: Calculation of Residual Value Cash Flow


Equipment cost
$715,000
Residual value (%)
11.2729%
Residual value proceeds
$80,601
Less: tax expense
$13,402
Residual cash flow
$67,199

Calculation of Tax Expense


Market value
Less net book value
Gain on sale
Tax expense
Calculation of Net Book Value
Equipment cost
Depreciation before tax
Net book value

xhibit 4

Present Value of Cash Outflows1

Residual
Depr.
Tax

Cash Flow
after

Savings

Tax4

($48,620)
($77,792)
($46,675)
($28,005)
($28,005)
($229,097)

($67,199)
($67,199)

Loan
Cash
Outflow5
$0
$114,498
$89,146
$124,447
$147,698
$85,515
$561,303
$469,273

Lease
Cash
Outflow6
$105,602
$105,602
$105,602
$105,602
$105,602
$0
$528,010
$469,273

thods of equipment financing: the loan financing alternative (also called buy-andxpenses, the alternative with the lower net present value will be more attractive to

n or loss from the sale. The tax expense equals the tax rate times the difference
below).

depreciation tax shield (shown as a negative value because it reduces expenses), and
ash flows occur in arrears.

ayments are made in advance.

alculation of Tax Expense

ss net book value

alculation of Net Book Value


quipment cost
epreciation before tax
et book value

$80,601
$41,184
$39,417
$13,402
$715,000
$673,816
$41,184

Exhibit 5
Sample Calculation of the Internal Rate of Return1
for Lease Financing
Lease

Year

0
1
2
3
4
5
Sum
IRR

Lease

Forgone Tax

Forgone

Initial

Payment

Payment

Savings

Residual Value

Purchase

Less

after

Associated with

after

Price

Incremental

Tax2

Depreciation2

Tax2

Saved

Cash Flow

($105,602)
($105,602)
($105,602)
($105,602)
($105,602)
$0
($528,010)

$715,000
($48,620)
($77,792)
($46,675)
($28,005)
($28,005)
($229,097)

($67,199)
($67,199)

$715,000

$609,398
($154,222)
($183,394)
($152,277)
($133,607)
($95,204)
($109,307)
6.27%

This table illustrates the calculation of the internal rate of return (IRR) associated with lease financing.
The IRR is the effective after-tax cost of the lease financing and is useful for comparison with the cost of
alternative forms of financing. Because this is a calculation based on costs to the customer, a lower IRR
will be more attractive to the customer.
1

See Sample Calculation of the Present Value of Cash Outflows.

Exhibit 6
Summary Table of the Net Present Value and Internal Rate of Return
For Four Tax and Cost-of-Capital Scenarios1
Scenario
Effective tax rate
Pretax cost of debt
After-tax cost of debt

A
34.0%
9.5%
6.27%

B
34.0%
13.0%
8.58%

NPV of loan (borrow-and-buy)


IRR of loan (borrow-and-buy)

$469,273
6.27%

$484,546
8.58%

Leasing option #1
NPV of leasing option #1
IRR of lease
Lease advantage over borrowing

$155,040
$454,717
5.32%
$14,556

$155,040

Leasing option #2
NPV of leasing option #2
IRR of lease
Lease advantage over borrowing

$160,003
$469,273
6.27%
$0

$160,003

Leasing option #3
NPV of leasing option #3
IRR of lease
Lease advantage over borrowing

$162,350
$476,156
6.72%
($6,883)

$162,350

Leasing option #4
NPV of leasing option #4
IRR of lease
Lease advantage over borrowing

$164,760
$483,225
7.19%
($13,952)

$164,760

Faulhaber Gmbh
NPV of loan
NPV of lease
IRR of lease
Lease advantage over borrowing
Honshu Heavy Industries
NPV of loan
NPV of lease
IRR of lease
Lease advantage over borrowing

Calculations in shaded cells are presented in Exhibits 4 and 5.

d Internal Rate of Return

al Scenarios1
C
0.0%
9.5%
9.50%

D
0.0%
13.0%
13.00%

$663,800
9.50%

$671,253
13.00%

$155,040

$155,040

$160,003

$160,003

$162,350

$162,350

$164,760

$164,760