PRIMUS

AUTOMATION
Robert Clark
Rey Mendez
Nate Wills
Katie Young

Primus Automation
Innovative producer of world-class factory-automation
products and services with operations in the United States,
Europe, and Asia.
Products:

Programmable controllers
Numerical controllers
Industrial computers
Manufacturing software
Factory-automation systems
Data communication networks

Objectives:
Maintain leadership in market share
Increase sales by 15% a year
Achieve its targets for net income and working capital turnover

Avantjet
Manufacturer of corporate-jet aircraft. Avantjet is
trying to acquire an automation system that will
cut costs and accelerate the companys
production line.
Some things to note:
Capital Intensive
Highly levered
CEO ordered a moratorium on any capital expenditures
that will negatively affect the income statement and
balance sheet

Financial Situation
In order for Avantjet to acquire the automation
system they could:
1. Acquire funds through borrowed funds
2. Acquire the equipment through a conditional sale title
passes to the firm upon receipt of the final payment
3. Lease the equipment in two ways:
I.

Capital Lease

II. Operating Lease

Lease Characteristics
A lease is a rental agreement that
involves a series of fixed payments that
extend over several periods.
Lessor owns the property that is leased.
Lessee acquires the assets productive
value from the lessor, but relinquishes the
residual value.
Residual Value- what the asset is worth at the end
of the lease

Lease Evaluation
By the lessee
Is leasing the asset less costly than buying it?
What company will offer the best leasing
terms?
By the lessor
Will the lease payments provide a satisfactory
return on the capital invested in the leased
asset?

Capital Lease
Spans the entire life of the asset, no
cancellation clause
Lessee retains ownership of the equipment
and is exposed to the risk of early changes
in the assets value
Lessee is required to depreciate the
equipment by showing it as an asset and
liability on their balance sheet
Not able to deduct the lease payment from
income taxes

Operating Lease
Cancellation clause
Technological obsolescence

Automation system would not appear on

Avantjets balance sheet and at the end of the
lease term, the equipment would revert back to
Primus Automation
Not fully amortized
Lessee discount
Lessor can renew, re-lease, or sell

Lease payments are treated as an ordinary

expense, deductible from taxable income

Balance Sheet

Income Statement

Loan Amortization Schedule

Loan Amortization Table

Year

BeginningBalance

$715,000

$596,713

$467,189

$325,360

$170,057

AnnualPayment

$186,212

186,212

186,212

186,212

186,212

186,212

InterestBeforeTax@

9.50%

67,925

56,688

44,383

30,909

16,155

PrincipalReduction

118,287

129,524

141,829

155,303

170,057

EndingBalance

$596,713

$467,189

$325,360

$170,057

$0

TaxRate

34.00%

InterestAfterTax

$44,831

$37,414

$29,293

$20,400

$10,663

PMT(Pretax Annual
Rate, Term,

-715000)
TotalInterestPaid
$142,600

TotalPrincipalPaid

$715,000

Calculating Operating Lease NPV

(Lessees Perspective)
Option 1

Exhibit 4
Sample Calculation of the Present Value of Cash Outflows1

34.00%

Equipmentcost: $715,000

Taxrate:
Pretaxinterestrate:

9.50%

Leasepayment: $155,040

Interest
Payment
after
Principal
Year Tax2 Payment2

Five-Year
MACRS3
Depr.
Rate

Residual
Depr.
before
Tax

Depr. CashFlow Loan

Lease
Tax
after
Cash
Cash
Savings
Tax4
Outflow5 Outflow6

$0 $102,326

1 $44,831 $118,287

20.00%

$143,000 ($48,620)

$114,498 $102,326

2 $37,414 $129,524

32.00%

$228,800 ($77,792)

$89,146 $102,326

3 $29,293 $141,829

19.20%

$137,280 ($46,675)

$124,447 $102,326

4 $20,400 $155,303
5 $10,663 $170,057
Sum $142,600 $715,000
NPV

11.52%
11.52%
94.24%

$82,368 ($28,005)
$147,698 $102,326
$82,368 ($28,005) ($67,199) $85,515
$0
$673,816 ($229,097) ($67,199) $561,303 $511,632
$469,273 $454,717

Calculating Lease NPV

(Lessors Perspective)
Option1
Year0
NetPurchasePrice

Year1

Year2

Year3

Year4

Year5

(715,000)

DepreciationTaxSavings

Kd
48,620 77,792 46,675 28,005 28,005

LeasePayment

155,040 155,040 155,040 155,040 155,040

TaxonLeasePayment

(52,714) (52,714) (52,714) (52,714) (52,714)

ResidualValue

67,199

TaxonResidualValue
NetCashFlow

(15,767)
(612,674) 150,946 180,118 149,001 130,331 79,437

NPV

(17,860)

IRR

4.52%

Tax 40.00%
9.50%

Calculating Lease IRR

Option 1

Year

Exhibit 5
Sample Calculation of the Internal Rate of Return1
for Lease Financing

Lease
Payment
after
Tax2

ForgoneTax
Forgone
Savings
ResidualValue
Associatedwith
after
Depreciation2
Tax2

Initial
Purchase
Price
Saved

$715,000

Lease
Payment
Less
Incremental
CashFlow

($108,742)

($108,742)

($48,620)

($157,362)

($108,742)

($77,792)

($186,534)

($108,742)

($46,675)

($155,417)

($108,742)

($28,005)

($136,747)

5
Sum
IRR

$0
($543,708)

($28,005)
($229,097)

($67,199)
($67,199)

$715,000

$606,258

($95,204)
($125,005)
7.19%

Leasing Options Offered by

Primus Equipment Finance Division

NPV for Primus

Options 1 & 2
Option1
Year0
NetPurchasePrice

Year1

Year2

Year3

Year4

Year5

(715,000)

DepreciationTaxSavings

48,620

77,792

46,675

28,005

28,005

LeasePayment

155,040

155,040

155,040

155,040

155,040

TaxonLeasePayment

(52,714)

(52,714)

(52,714)

(52,714)

(52,714)

ResidualValue

67,199

TaxonResidualValue
NetCashFlow

NPV

(15,767)
(612,674)

150,946

180,118

149,001

130,331

79,437

(17,860)

IRR

4.52%

Option2
Year0

Year1

Year2

Year3

Year4

Year5

Tax

40.00%

Kd

9.50%

NPV for Primus

Options 3 & 4
Option3
Year0
NetPurchasePrice

Year1

Year2

Year3

Year4

Year5

(715,000)

DepreciationTaxSavings

48,620

77,792

46,675

28,005

28,005

LeasePayment

162,349

162,350

162,350

162,350

162,350

TaxonLeasePayment

(55,199)

(55,199)

(55,199)

(55,199)

(55,199)

ResidualValue

67,199

TaxonResidualValue
NetCashFlow

(15,767)
(607,850)

NPV

3,798

IRR

5.95%

155,771

184,943

153,826

135,156

79,437

Option4
Year0

Year1

Year2

Year3

Year4

Year5

Tax

40.00%

Kd

9.50%

Summary
Scenario
Effective tax rate
Pretax cost of debt
After-tax cost of debt

A
34.0%
9.5%
6.27%

NPV of loan (borrow-and-buy)

IRR of loan (borrow-and-buy)

$469,273
6.27%

B
34.0%
13.0%
8.58%

$484,546
8.58%

C
0.0%
9.5%
9.50%

D
0.0%
13.0%
13.00%

$663,800
9.50%

$671,253
13.00%

Leasing option #1

NPV of leasing option #1

IRR of lease
Lease advantage over borrowing

$155,040

$454,717
5.32%
$14,556

$155,040

436,915
5.32%
$47,631

$155,040

$155,040

651,863
8.61%
$11,937

616,202
8.61%
$55,050

Leasing option #2

NPV of leasing option #2

IRR of lease
Lease advantage over borrowing

$160,003

$469,273
6.27%
$0

$160,003

$450,901
6.27%
$33,645

$160,003

$160,003

$672,730
10.17%
($8,930)

$635,927
10.17%
$35,326

Leasing option #3

NPV of leasing option #3

IRR of lease
Lease advantage over borrowing

$162,350

$476,156
6.72%
($6,883)

$162,350

$457,515
6.72%
$27,031

$162,350

$162,350

$682,598
10.91%
($18,797)

$645,255
10.91%
$25,9978

Leasing option #4

NPV of leasing option #4

IRR of lease
Lease advantage over borrowing

$164,760

$483,225
7.19%
($13,952)

$164,760

$464,306
7.19%
$20,239

$164,760

$692,730
11.68%
($28,930)

$164,760

$654,834
11.68%
$16,419

Summary
Scenario
Effective tax rate
Pretax cost of debt
After-tax cost of debt

A
34.0%
9.5%
6.27%

NPV of loan (borrow-and-buy)

IRR of loan (borrow-and-buy)

B
34.0%
13.0%
8.58%

$469,273
6.27%

$484,546
8.58%

C
0.0%
9.5%
9.50%

D
0.0%
13.0%
13.00%

$663,800
9.50%

$671,253
13.00%

Leasing option #3

NPV of leasing option #3

IRR of lease
Lease advantage over borrowing
Faulhaber Gmbh

NPVofloan
NPVoflease
IRRoflease
Leaseadvantageover
borrowing

$162,350

$476,156
6.72%
($6,883)

$162,350

$457,515
6.72%
$27,031

$162,350

$162,350

$682,598
10.91%
($18,797)

$645,255
10.91%
$25,997

170,000

170,000

170,000

170,000

484,376
498,593
7.13%

501,993
479,073
7.13%

686,679
714,762
11.42%

697,207
675,660
11.42%

($14,217)

$22,920

($28,082)

$21,546

163,000

163,000

163,000

163,000

438,036
478,063
8.64%

458,436
459,346
8.64%

624,641
685,330
13.48%

640,997
647,839
13.48%

($40,027)

($911)

($60,689)

($6,842)

Honshu Heavy Industries

NPVofloan
NPVoflease
IRRoflease
Leaseadvantageover
borrowing

AvantJets Net Advantage of Leasing

over Borrowing
Option 1

Option 2

AvantJets Net Advantage of Leasing

over Borrowing
Option 3

Option 4
Net Advantage of Leasing Determined by Cost of Capital and
Tax Rate
Tax
Cost of Capital
10.00 10.50 11.00 11.50 12.00 12.50 13.00

9.50%
%
%
%
%
%
%
%
(13,95
34%
2) (8,872) (3,858) 1,089 5,971 10,790 15,546 20,240
(17,46 (11,868
25%
4)
) (6,354) (923) 4,429 9,702 14,899 20,020
(21,75 (15,628
15%
7)
) (9,601) (3,673) 2,158 7,893 13,535 19,086
(28,93 (22,074 (15,349
0%
0)
)
) (8,752) (2,280) 4,071 10,303 16,419

Primus
Vs.
Faulhaber Gmbh

Option 3
Net Advantage of Leasing Determined
Tax

9.50% 10.00% 10.50%

34%
22,437 22,307
22,178
25%
25,117 24,954
24,794
15%
28,004 27,802
27,604
0%
32,164 31,899
31,639

by Cost of Capital and Tax Rate (AvantJet)

Cost of Capital
11.00% 11.50% 12.00%
12.50% 13.00%
22,051
21,926
21,802
21,679
21,558
24,636
24,479
24,325
24,173
24,023
27,408
27,215
27,026
26,839
26,655
31,384
31,133
30,886
30,643
30,405

Option 4
Net Advantage of Leasing Determined
Tax

9.50% 10.00% 10.50%

34%
15,368 15,279
15,191
25%
17,204 17,093
16,983
15%
19,182 19,044
18,907
0%
22,031 21,850
21,672

by Cost of Capital and Tax Rate (Avantjet)

Cost of Capital
11.00% 11.50% 12.00%
12.50% 13.00%
15,104
15,018
14,933
14,850
14,767
16,875
16,768
16,662
16,558
16,455
18,774
18,642
18,512
18,384
18,258
21,497
21,325
21,156
20,990
20,826

Primus
Vs.
Honshu Heavy Industries

Option 3
Net Advantage of Leasing Determined
Tax

9.50% 10.00% 10.50%

34%
1,906 1,895
1,884
25%
2,134 2,120
2,107
15%
2,379 2,362
2,345
0%
2,733 2,710
2,688

by Cost of Capital and Tax Rate (AvantJet)

Cost of Capital
11.00% 11.50% 12.00%
12.50% 13.00%
1,874
1,863
1,852
1,842
1,832
2,093
2,080
2,067
2,054
2,041
2,329
2,312
2,296
2,280
2,265
2,667
2,645
2,624
2,604
2,583

Option 4

Net Advantage of Leasing Determined

Tax
9.50% 10.00% 10.50%
34%
(5,162) (5,132) (5,102)
25%
(5,779) (5,741) (5,704)
15%
(6,443) (6,396) (6,351)
0%
(7,400) (7,339) (7,279)

by Cost of Capital and Tax Rate (Avantjet)

Cost of Capital
11.00% 11.50% 12.00%
12.50% 13.00%
(5,073) (5,044) (5,016)
(4,988) (4,960)
(5,668) (5,632) (5,596)
(5,561) (5,527)
(6,306) (6,261) (6,218)
(6,175) (6,132)
(7,220) (7,163) (7,106)
(7,050) (6,995)

Decision Summary

Pick Option 3
Operating lease
Option 1 and 2 do not give Primus a positive NPV
Option 3 and 4 give Primus a positive NPV
However, with option 4 there would not be a
net advantage to leasing between Primus and
Honshu Heavy Industries, so we would risk
potentially losing this business.

THIS IS OUR STORY

AND WERE STICKING TO IT!