NEW EQUIPMENT – TO PAY CASH, RENT, GET A LOAN, OR LEASE?
EAGLE SOAR needs new, state of the art equipment. The management team has already identified a vendor for this equipment and a package that costs $50,000.
EAGLE SOAR has $65,000 in cas reserves and other assets available to make this purchase. You budget $5,000 in monthly operating expenses and set aside $500 per month in your reserve account.
If you rent the equipment there is no up-front cash expenditure, except for a $1,000 security deposit. You will face lower upkeep and repair costs. You can also return the equipment if you are not satisfied. The monthly rental fee is $1,200 and it is 100% tax deductible.
A local bank is willing to extend you a simple interest business loan (multiply principle by interest rate to calculate finance charges) of $40,000 over 5 years at 4% with no money down. They will not offer the full amount because equipment will depreciate and they want to minimize their exposure (i.e., financial risk).
Since you have excellent credit and good cash flow the vendor offers to a “lease to own plan” to you the equipment. They are offering 100% financing over 5 years. Their terms are a 3% down payment that would cover any taxes, installation, and delivery expenses. You would pay $980 per month. Similar to renting, lease payments are tax deductible.
Your new manager tells you that EAGLE SOAR averages a quarterly profit before taxes of $18,000 and your tax rate is 30% (Federal and State combined).
1. What are the different ways you can purchase this equipment AND what is your upfront cost for each option?
2. What is your monthly cost for each option over the next 5 years? (Note: disregard maintenance)
3. What is your total cost for each option over the next 5 years? (Note: disregard maintenance and depreciation)
4. What is your project monthly tax liability under each option?
5. What is your recommendation to the manager about how to pay for the equipment? Use the information above to justify your rationale and response.