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 A

Year 1 2 3 4 5
Beginning Balance $ 715,000 $ 596,713 $467,189 $325,360 $170,057
Annual Payment $186,212 186,212 186,212 186,212 186,212 186,212
Interest Before Tax @ 9.50% 67,925 56,688 44,383 30,909 16,155
Principal Reduction 118,287 129,524 141,829 155,303 170,057
Ending Balance $ 596,713 $467,189 $325,360 $170,057 $0
Tax Rate 34.00%

Interest After Tax $44,831 $37,414 $29,293 $20,400 $10,663

Total Interest Paid $142,600

Total Principal Paid $715,000

PMT(Pretax Annual Rate, Term, -715000)

 Calculating Operating Lease NPV
(Lessees Perspective)
Option 1 A
Exhibit 4
Sample Calculation of the Present Value of Cash Outflows1

Tax rate: 34.00% Equipment cost: $ 715,000

Pretax interest rate: 9.50% Lease payment: $ 155,040

Interest Five-Year Residual

Payment MACRS3 Depr. Depr. Cash Flow Loan Lease
after Principal Depr. before Tax after Cash Cash
Year Tax 2 Payment2 Rate Tax Savings Tax 4 Outflow Outflow6
5

0 $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 11.52% $82,368 ($28,005) $147,698 $102,326
5 $10,663 $170,057 11.52% $82,368 ($28,005) ($67,199) $85,515 $0
Sum $142,600 $715,000 94.24% $673,816 ($229,097) ($67,199) $561,303 $511,632
NPV $469,273 $454,717
 Calculating Lease NPV
(Lessors Perspective)
Option 1
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Tax 40.00%
Net Purchase Price (715,000) Kd 9.50%
Depreciation Tax Savings 48,620 77,792 46,675 28,005 28,005
Lease Payment 155,040 155,040 155,040 155,040 155,040
Tax on Lease Payment (52,714) (52,714) (52,714) (52,714) (52,714)
Residual Value 67,199
Tax on Residual Value (15,767)
Net Cash Flow (612,674) 150,946 180,118 149,001 130,331 79,437

NPV (17,860)
IRR 4.52%
 Calculating Lease IRR
Option 1 A
Exhibit 5
Sample Calculation of the Internal Rate of Return1
for Lease Financing

Lease
Lease Forgone Tax Forgone Initial Payment
Payment Savings Residual Value Purchase Less
after Associated with after Price Incremental
Year Tax2 Depreciation2 Tax2 Saved Cash Flow
0 ($108,742) $ 715,000 $606,258
1 ($108,742) ($48,620) ($157,362)
2 ($108,742) ($77,792) ($186,534)
3 ($108,742) ($46,675) ($155,417)
4 ($108,742) ($28,005) ($136,747)
5 $0 ($28,005) ($67,199) ($95,204)
Sum ($543,708) ($229,097) ($67,199) $715,000 ($125,005)
IRR 7.19%
 Leasing Options Offered by
Primus Equipment Finance Division
 NPV for Primus
Options 1 & 2
Option 1
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Tax 40.00%
Net Purchase Price (715,000) Kd 9.50%
Depreciation Tax Savings 48,620 77,792 46,675 28,005 28,005
Lease Payment 155,040 155,040 155,040 155,040 155,040
Tax on Lease Payment (52,714) (52,714) (52,714) (52,714) (52,714)
Residual Value 67,199
Tax on Residual Value (15,767)
Net Cash Flow (612,674) 150,946 180,118 149,001 130,331 79,437

NPV (17,860)
IRR 4.52%

Option 2
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Net Purchase Price (715,000)
Depreciation Tax Savings 48,620 77,792 46,675 28,005 28,005
Lease Payment 160,002 160,003 160,003 160,003 160,003
Tax on Lease Payment (54,401) (54,401) (54,401) (54,401) (54,401)
Residual Value 67,199
Tax on Residual Value (15,767)
Net Cash Flow (609,399) 154,222 183,394 152,277 133,607 79,437

NPV (3,156)
IRR 5.49%
 NPV for Primus
Options 3 & 4
Option 3
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Tax 40.00%
Net Purchase Price (715,000) Kd 9.50%
Depreciation Tax Savings 48,620 77,792 46,675 28,005 28,005
Lease Payment 162,349 162,350 162,350 162,350 162,350
Tax on Lease Payment (55,199) (55,199) (55,199) (55,199) (55,199)
Residual Value 67,199
Tax on Residual Value (15,767)
Net Cash Flow (607,850) 155,771 184,943 153,826 135,156 79,437

NPV 3,798
IRR 5.95%

Option 4
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Net Purchase Price (715,000)
Depreciation Tax Savings 48,620 77,792 46,675 28,005 28,005
Lease Payment 164,759 164,760 164,760 164,760 164,760
Tax on Lease Payment (56,018) (56,018) (56,018) (56,018) (56,018)
Residual Value 67,199
Tax on Residual Value (15,767)
Net Cash Flow (606,259) 157,362 186,534 155,417 136,747 79,437

NPV 10,938
IRR 6.43%
 Summary
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%

NPV of loan (borrow-and-buy) $469,273 $484,546 $663,800 $671,253

IRR of loan (borrow-and-buy) 6.27% 8.58% 9.50% 13.00%

Leasing option #1 $155,040 $155,040 $155,040 $155,040

NPV of leasing option #1 $454,717 436,915 651,863 616,202
IRR of lease 5.32% 5.32% 8.61% 8.61%
Lease advantage over borrowing $14,556 $47,631 $11,937 $55,050

Leasing option #2 $160,003 $160,003 $160,003 $160,003

NPV of leasing option #2 $469,273 $450,901 $672,730 $635,927
IRR of lease 6.27% 6.27% 10.17% 10.17%
Lease advantage over borrowing $0 $33,645 ($8,930) $35,326

Leasing option #3 $162,350 $162,350 $162,350 $162,350

NPV of leasing option #3 $476,156 $457,515 $682,598 $645,255
IRR of lease 6.72% 6.72% 10.91% 10.91%
Lease advantage over borrowing ($6,883) $27,031 ($18,797) $25,9978

Leasing option #4 $164,760 $164,760 $164,760 $164,760

NPV of leasing option #4 $483,225 $464,306 $692,730 $654,834
IRR of lease 7.19% 7.19% 11.68% 11.68%
Lease advantage over borrowing ($13,952) $20,239 ($28,930) $16,419
 Summary
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%

NPV of loan (borrow-and-buy) $469,273 $484,546 $663,800 $671,253

IRR of loan (borrow-and-buy) 6.27% 8.58% 9.50% 13.00%

Leasing option #3 $162,350 $162,350 $162,350 $162,350

NPV of leasing option #3 $476,156 $457,515 $682,598 $645,255
IRR of lease 6.72% 6.72% 10.91% 10.91%
Lease advantage over borrowing ($6,883) $27,031 ($18,797) $25,997
Faulhaber Gmbh 170,000 170,000 170,000 170,000
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 ($14,217) $22,920 ($28,082) $21,546

Honshu Heavy Industries 163,000 163,000 163,000 163,000

NPV of loan 438,036 458,436 624,641 640,997
NPV of lease 478,063 459,346 685,330 647,839
IRR of lease 8.64% 8.64% 13.48% 13.48%
Lease advantage over
borrowing ($40,027) ($911) ($60,689) ($6,842)
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
9.50% 10.00% 10.50% 11.00% 11.50% 12.00% 12.50% 13.00%
34% (13,952) (8,872) (3,858) 1,089 5,971 10,790 15,546 20,240
25% (17,464) (11,868) (6,354) (923) 4,429 9,702 14,899 20,020
15% (21,757) (15,628) (9,601) (3,673) 2,158 7,893 13,535 19,086
0% (28,930) (22,074) (15,349) (8,752) (2,280) 4,071 10,303 16,419
 Primus
Vs.
Faulhaber Gmbh
Option 3
Net Advantage of Leasing Determined by Cost of Capital and Tax Rate (AvantJet)
Tax Cost of Capital
9.50% 10.00% 10.50% 11.00% 11.50% 12.00% 12.50% 13.00%
34% 22,437 22,307 22,178 22,051 21,926 21,802 21,679 21,558
25% 25,117 24,954 24,794 24,636 24,479 24,325 24,173 24,023
15% 28,004 27,802 27,604 27,408 27,215 27,026 26,839 26,655
0% 32,164 31,899 31,639 31,384 31,133 30,886 30,643 30,405

Option 4
Net Advantage of Leasing Determined by Cost of Capital and Tax Rate (Avantjet)
Tax Cost of Capital
9.50% 10.00% 10.50% 11.00% 11.50% 12.00% 12.50% 13.00%
34% 15,368 15,279 15,191 15,104 15,018 14,933 14,850 14,767
25% 17,204 17,093 16,983 16,875 16,768 16,662 16,558 16,455
15% 19,182 19,044 18,907 18,774 18,642 18,512 18,384 18,258
0% 22,031 21,850 21,672 21,497 21,325 21,156 20,990 20,826
 Primus
Vs.
Honshu Heavy Industries
Option 3
Net Advantage of Leasing Determined by Cost of Capital and Tax Rate (AvantJet)
Tax Cost of Capital
9.50% 10.00% 10.50% 11.00% 11.50% 12.00% 12.50% 13.00%
34% 1,906 1,895 1,884 1,874 1,863 1,852 1,842 1,832
25% 2,134 2,120 2,107 2,093 2,080 2,067 2,054 2,041
15% 2,379 2,362 2,345 2,329 2,312 2,296 2,280 2,265
0% 2,733 2,710 2,688 2,667 2,645 2,624 2,604 2,583

Option 4
Net Advantage of Leasing Determined by Cost of Capital and Tax Rate (Avantjet)
Tax Cost of Capital
9.50% 10.00% 10.50% 11.00% 11.50% 12.00% 12.50% 13.00%
34% (5,162) (5,132) (5,102) (5,073) (5,044) (5,016) (4,988) (4,960)
25% (5,779) (5,741) (5,704) (5,668) (5,632) (5,596) (5,561) (5,527)
15% (6,443) (6,396) (6,351) (6,306) (6,261) (6,218) (6,175) (6,132)
0% (7,400) (7,339) (7,279) (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!