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Praeda Inc. has the choice of buying a piece of equipment or leasing it
Praeda Inc. has the choice of buying a piece of equipment or leasing it. The purchase cost of the equipment will be $155,000. For tax purposes, the depreciation on the machine will be full, straight-line depreciation over 7 years. The machine will be used for 5 years, regardless of whether it is purchased or leased. The machine is expected to have a market value of $70,250 at the end of the 5 years. The lessor will require annual payments of $21,000. A total of 5 annual payments will be required under the lease contract, with the first payment due immediately (that is, at the start of the first year). The lease will be treated as an operating lease for tax and reporting purposes.
Praeda Inc. pays 6.25% interest on its loans, and its weighted average cost of capital is 8.75%. The company faces a marginal tax rate of 21%.
- What is the cost of leasing?
- What is the cost of borrowing?
- Should Praeda Inc. lease the machine, or should it buy the machine? You must explain your answer in order to get any credit.
Clementi Corp. has debt in the form of 8.00% coupon bonds that have 14 years
Clementi Corp. has debt in the form of 8.00% coupon bonds that have 14 years remaining until maturity. These bonds pay interest semiannually, and have a yield of 4.25% at the present time. The book value of these bonds is $125 million. The company’s common stock is currently trading at 88.90 per share. There are 2.25 million shares of Clementi stock outstanding. The firm has no preferred stock. There is insufficient price history for Clementi stock to allow you to estimate the company’s equity beta, so you turn to a comparable firm that has sufficient data.
You use regression analysis to estimate the beta for this comparable firm. Your results suggest a beta of 1.30. In market value terms, the comparable firm has a $298 million of debt and $480 million of equity. Both Clementi Corp. and the comparable firm face a 35% marginal tax rate.
- Estimate the equity beta for Clementi Corp.
- If the risk-free rate is 2.80% and the market risk premium is 6.25%, estimate the required rate of return on Clementi stock.
Better-Rock & Co is bidding on a contract to supply 85000 units per year for 3 years
Better-Rock & Co is bidding on a contract to supply 85000 units per year for 3 years
Better-Rock & Co. is bidding on a contract to supply 85,000 units per year for 3 years of a special type of geophone used in oil exploration. The equipment required to produce these geophones has an installed cost of $4.2 million. An estimated $200,000 will have to be invested initially in net working capital (to be recovered at project end). The equipment will be depreciated on a straight-line basis on a 5-year schedule, and sold at the end of 3 years for an estimated $2.2 million.
Annual fixed operating costs (other than depreciation) are expected to be $320,000. Variable operating costs should amount to 30% of sales revenue. Better-Rock & Co. has a required return of 12% on this project. Its marginal tax rate is 35%. What per-unit price should Better-Rock bid at a minimum?