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The business environment had changed dramatically over the past year, Slower economic
growth, coupled with increased competition for market share is also forecasted for the
next few years. With this economic downturn, Primus goal is to maintain leadership in
market share and increase its sales by 15% a year. To do this, Primus must stimulate the
demand by creating new incentives for purchasing automation equipment. Thus, Primus
executives must discuss various asset financing approaches as a means of assisting with
the placement of their systems.
However, the tax exposure and debt rating of the Avantjet were uncertain, hence
Baumann need to estimate the impact of alternative lease terms under different tax and
interest-rate assumptions. Avantjet was also considering the lease of competing systems
from Faulhaber Gmbh and Honshu Heavy industries. These competing proposals limited
Primuss flexibility in tailoring its proposal.
If it leases the system to Avantjet, Primus is in effect making a credit decision. Accordingly,
Primus assumes various credit-related risks and must decide whether the rate of return
on the lease is sufficient to compensate the firm for the risk. If it does not lease the
system, however, Primus will probably lose the customer. Thus, Baumanns problem is to
assess the risks and determine whether the investment is economically attractive.
III. CASE ANALYSIS
The completed table for NPV and IRR for the four tax and cost of capital structure is
provided below (please see excel computation):
Scenario A B C D
Effective tax rate 34.0% 34.0% 0.0% 0.0%
Pretax cost of debt 9.5% 13.0% 9.5% 13.0%
After-tax cost of debt 6.27% 8.58% 9.50% 13.00%
Faulhaber Gmbh
NPV of loan $484,376 $501,993 $686,679 $697,207
NPV of lease $498,593 $479,073 $714,762 $675,660
IRR of lease 7.13% 7.13% 11.42% 11.42%
Lease advantage over borrowing ($14,218) $22,920 ($28,082) $21,547
Based on the above data, we can deduce that leasing option one can give Primus a leasing advantage than
that of borrowing. Thus, we can conclude that the lower the IRR, the more attractive the leasing option
is. However, Option 1 gives a lower IRR of 6.27%, this means that this is not acceptable.
IV. RECOMMENDATION
Primus must offer Option 2 to Avantjet. This would give them a positive NPV and IRR equal to their cost-
of-debt.
Primus has also an advantage over its competitors if Avantjet has to lease the automation system. Hence,
Baumann must convince Avantjent to lease it instead of having a loan then buy the automation system.