## (solution) As a baseline, assume all cash flows have the same risk; that is,

As a baseline, assume all cash flows have the same risk; that is, ignore residual value risk and use the same discount rate for all lessee and lessor cash flows.

Should the Center lease the equipment?  Should GBF write the lease?

Who is getting the better deal?  Explain.

What is the maximum lease payment that the Center would be willing to pay?

What factor influence whether the actual lease payment will be closer to the Center?s maximum lease payment or GBF?s minimum lease payment?

This lease is attractive to both parties because there is asymmetry of inputs between the lessee and lessor.

What are these asymmetries?

What would be the result if there were no asymmetries?  Prove it.

Model CASE 17

9/25/2016 Student Version

SEATTLE CANCER CENTER

Leasing Decisions This case illustrates the lease versus purchase decision from the standpoints of both the lessee

and the lessor.

The model calculates the NAL (or NPV) and IRR of the lease for both parties on the basis of

relevant input data. The invoice price and lease rental payments must be the same for both

parties, but the other input variables may be different for each party. The model also examines

the differential profitability to the lessee between conventional and per procedure leases.

The model consists of a complete base case analysis--no changes need to be made

to the existing MODEL-GENERATED DATA section. However, all values in the student version

INPUT DATA section have been replaced with zeros. Thus, students must determine

the appropriate input values and enter them into the model. These cells are colored red.

When this is done, any error cells will be corrected and the base case solution will appear.

Note that the model does not contain any risk analyses, so students will have to create

their own if required by the case. Furthermore, students must create their own graphics

(charts) as needed to present their results.

Both instructor and student versions contains a sheet (Figure 1) that plots lessee's NAL,

lessor's NPV, and total contract value versus the size of the lease payment. INPUT DATA: KEY OUTPUT: General Data:

Invoice price

Annual lease payment

Net revenue per procedure

Per procedure lease payment Lessee:

\$3,000,000

\$675,000

\$10,000

\$7,000 For Lessee Only:

Maintenance contract cost

Loan interest (discount) rate

Estimated residual value

Residual value discount rate

Tax rate \$100,000

8.0%

\$1,125,000

8.0%

0.0% For Lessor Only: NAL

IRR

Lessor:

Unleveraged lease:

NPV

IRR

Leveraged lease:

NPV

IRR

Per Procedure Versus Annual Lease:

(Volume = procedures annually) Page 1 Model Maintenance contract

Opportunity cost rate

Estimated residual value

Residual value discount rate

Tax rate

Leveraged lease inputs:

Amount borrowed

Interest rate \$100,000

8.0%

\$1,500,000

8.0%

40.0% Per procedure lease

Annual lease

Difference \$1,500,000

8.0% MODEL-GENERATED DATA:

MACRS Depreciation Table: Year

1

2

3

4

5

6 MACRS

Rate

0.20

0.32

0.19

0.12

0.11

0.06 Basis

\$3,000,000

3,000,000

3,000,000

3,000,000

3,000,000

3,000,000 Depreciation

Expense

\$600,000

960,000

570,000

360,000

330,000

180,000

\$3,000,000 Ending

Book Value

\$2,400,000

1,440,000

870,000

510,000

180,000

0 Lessee's Annual Analysis:

Base Discount Rate:

Residual Value Discount Rate: 8.0%

8.0% Cost of Owning: Equipment cost

Maintenance

Maint tax savings

Depreciation shield

Residual value

Residual value tax Year 0

(\$3,000,000)

(100,000)

0 Net owning CF (\$3,100,000) PV cost owning: (\$2,530,801) Year 1 Year 2 Year 3 (\$100,000)

0

0 (\$100,000)

0

0 (\$100,000)

0

0 (\$100,000) (\$100,000) (\$100,000) Cost of Leasing:

Page 2 Model Lease payment

Payment tax savings (\$675,000)

0 (\$675,000)

0 (\$675,000)

0 (\$675,000)

0 Net leasing CF (\$675,000) (\$675,000) (\$675,000) (\$675,000) PV cost leasing: (\$2,414,540) NAL = PV cost of leasing - PV cost of owning = \$116,261 Net Cost of Leasing versus Owning:

Lease CF - Own CF \$2,425,000 (\$575,000) Lessee's IRR = (\$575,000) (\$575,000) 6.0% Lessor's Annual Analysis:

Base Discount Rate:

Residual Value Discount Rate: 4.8%

4.8% Cash Flow Analysis: Equipment cost

Maintenance

Maint tax savings

Depreciation shield

Lease payment

Tax on payment

Residual value

Residual value tax

Net cash flow Year 0

(\$3,000,000)

(100,000)

40,000 Year 1 Year 2 Year 3 675,000

(270,000) (\$100,000)

40,000

240,000

675,000

(270,000) (\$100,000)

40,000

384,000

675,000

(270,000) (\$100,000)

40,000

228,000

675,000

(270,000) (\$2,655,000) \$585,000 \$729,000 \$573,000 Lessor's NPV =

Lessor's IRR = \$99,368

6.2% Leveraged Lease: Unleveraged CF

Unleveraged CF

Loan amount Year 0

(\$2,655,000) Year 1

\$585,000 1,500,000

Page 3 Year 2

\$729,000 Year 3

\$573,000 Model Interest

Int tax savings

Principal repay

Net cash flow (\$1,155,000) (120,000)

48,000 (120,000)

48,000 (120,000)

48,000 \$513,000 \$657,000 \$501,000 Lessor's NPV =

Lessor's IRR = \$99,368

10.6% Lease Payment Analysis Graphics Data:

(Note: This table does NOT automatically recalculate when input values are changed.) Lease Payment

\$600,000

\$620,000

\$640,000

\$660,000

\$680,000

\$700,000

\$720,000 Lessee's

NAL

\$0

\$0

\$0

\$0

\$0

\$0

\$0 Lessor's

NPV

\$0

\$0

\$0

\$0

\$0

\$0

\$0 Total

Value

\$0

\$0

\$0

\$0

\$0

\$0

\$0 Lessee's Per Procedure Analysis: Num

of

Proc

70

80

90

100

110

120

130 Per Procedure Lease

Annual

Annual

Lease

Net

Payment

Revenue

\$490,000

\$700,000

\$560,000

\$800,000

\$630,000

\$900,000

\$700,000

\$1,000,000

\$770,000

\$1,100,000

\$840,000

\$1,200,000

\$910,000

\$1,300,000 Annual

Profit

\$210,000

\$240,000

\$270,000

\$300,000

\$330,000

\$360,000

\$390,000 Page 4 Annual

Lease

Payment

\$675,000

\$675,000

\$675,000

\$675,000

\$675,000

\$675,000

\$675,000 Annual Lease

Annual

Net

Revenue

\$700,000

\$800,000

\$900,000

\$1,000,000

\$1,100,000

\$1,200,000

by FACHE oth the lessee e basis of

e for both

so examines dent version appear. raphics \$116,261

6.0% \$99,368

6.2% \$99,368

10.6% sus Annual Lease:

dures annually)

Page 5 Model Profit

\$300,000

325,000

(\$25,000) Year 4 \$0

1,125,000

0

\$1,125,000 Page 6 Model \$0 (\$1,125,000) Year 4 \$144,000 1,500,000

(396,000)

\$1,248,000 Year 4

\$144,000 All except RV flows

1,104,000 RV flows

Page 7 Model (120,000)

48,000

(1,500,000)

(\$324,000) al Lease

Annual

Profit

\$25,000

\$125,000

\$225,000

\$325,000

\$425,000

\$525,000

\$625,000 Profit

Difference

\$185,000

\$115,000

\$45,000

(\$25,000)

(\$95,000)

(\$165,000)

(\$235,000) END Page 8

Solution details:

STATUS

QUALITY

Approved

Sep 13, 2020

EXPERT

Tutor