Tax Payment

The company have decided to install a new machine.The machine costs $2000 and it is estimated that it will have a useful life of five years with a trade value or $4000 at the end of the fifth year. Management have estimated that the new machine would yield additional cash profit of $8000 per year for the next 5 years. The management are considering two different ways of financing the new machine.

Option One

Purchase the machine for cash, by borrowing money from the bank. The interest cost would be 14% before tax.

Option Two

Lease the machine under an agreement which would require the firm to make a $4800 payment to the leasing company at the end of each year for the next 5 years.

The company’s weighted average cost of capital (WACC ) is 13% after tax and the company pays tax at 35 %.If the company decide to purchase the machine they will be able to claim a writing down allowance of 25% of the reducing balance per anumn.This would mean that the first write down allowance would be claimed in a year one resulting in a tax saving for year two.

Required:

• Prepare a a financial statement to show whether or not the firm should acquire the machine
• Prepare a financial statement showing how the firm should finance the new machine
• Why is the use of an asset more important to a firm than its ownership and outline after factors which should be considered by the firm’s management before making a decision to acquire the machine?