Michael Cleaners needs a new steam finishing machine that costs $100,000. The company is evaluating whether it should lease or purchase the machine. The equipment falls into the MACRS 3-year class, and it would be used for 4 years and then sold, because the firm plans to move to a new facility at that time. The estimated value of the equipment after 4 years is $10,000. A maintenance contract on the equipment would cost $3,000 per year, payable at the beginning of each year. Alternatively, the firm could lease the equipment for 4 years for a lease payment of $29,000 per year, payable at the beginning of each year. The lease would include maintenance. Due to special circumstances, the firm is in the 20% tax bracket, and it could obtain debt at a before-tax cost of 10%. If there is a positive Net Advantage to Leasing the firm will lease the equipment. Otherwise, it will buy it. MACRS rates for Years 1 to 4 are 0.3333, 0.4445, 0.1481, and 0.0741. What is the difference in cash flow at inception (Buying Cash flow compared to Leasing Cash flow) - ignore cash inflow of any external debt on the buy-side? a. Buying cash out flow $59,200 higher than leasing cash flow b. Buying cash out flow $71,000 higher than leasing cash flow c. Buying cash out flow $79,200 higher than leasing cash flow d. Buying cash out flow $74,000 higher than leasing cash flow
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
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