Primus

Primus Homework Questions

1. How did Tom Baumann analyze the problem of setting the lease-financing terms? How does he calculate NPV and internal rate of return (IRR) for the lease and borrow-and-buy alternatives? Please complete case Exhibit 6.

Tom Baumann was weighing a choice among four alternatives sets of lease terms. To be classified as a capital lease under the guidelines of Financial Accounting Standards Board Statement no.13, the lease had to meet one or more of the following four criteria:

· Ownership of the asset transferred by the end of the lease term

· The lease contained a bargain-purchase option, whereby the lessee had to pay the fair market value for the property at the end of the lease

· The lease term was equal to 75% or more of the economic life of the property

· The present value of the lease payments over the lease term was equal to or greater than 90% of the fair market value of the leased property at the beginning of the lease

In order for Avantjet to acquire the automation system they could:

· Acquire funds through borrowed funds

· Acquire the equipment through a conditional sale – title passes to the firm upon receipt of the final payment

· Lease the equipment in two ways:

- Capital lease

- Operating lease

To analyze leasing scenarios, Baumann created a leasing model for computing the net present value (NPV) and the internal rate of return (IRR) of cash flows to get a better understanding of which alternative would be the least costly to Avantjet. The scenario with the lowest present value would be the cheapest financing alternative. The IRR represented the effective cost of the lease financing. If that rate were below the after-tax cost of debt, leasing would be the more attractive method of financing.

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