Question

Felix company owns equipment with a cost of $366,700 and accumulated depreciation of $54,900 that can be sold for $276,300, less a 4% sales commission. Alternatively, Felix company can lease the equipment for three years for a total of $286,500, at the end of which there is no residual value. In addition, the repair, insurance, and property tax expense that would be incurred by Felix company on the equipment would total $15,500 over the three-year lease. Should Felix company lease (alternative 1) or sell (alternative 2) the equipment? Prepare a differential analysis on August 7. Use a minus sign to indicate a loss if required.

Answer 1

After performing a differential analysis, Felix Company would have a higher net cash inflow from leasing the equipment for $271,000 compared to selling it after considering the sales commission and loss on sale, which would result in a net inflow of $265,248. As such, leasing the equipment is the preferable option.

Step-by-step explanation:

To determine whether Felix Company should lease or sell its equipment, we need to compare the net cash flows under each option. Option 1 (Lease): The total cash inflow from leasing is $286,500. However, Felix must also cover $15,500 in expenses over the lease term, resulting in a net inflow of $286,500 - $15,500 = $271,000. Option 2 (Sell): If the equipment is sold for $276,300 and incurs a 4% sales commission, Felix will receive $276,300 - ($276,300 × 0.04) = $276,300 - $11,052 = $265,248. It's important to note that the equipment's book value is its cost ($366,700) minus accumulated depreciation ($54,900), which is $366,700 - $54,900 = $311,800. Selling the equipment for $265,248 when the book value is $311,800 would result in a loss of $311,800 - $265,248 = $46,552.

Comparing the two options, Felix Company's net advantage would be higher if they lease the equipment rather than sell it, as leasing yields a net cash inflow of $271,000 whereas selling would result in a net cash inflow of $265,248 after accounting for the loss on sale. Therefore, leasing is the preferable option. The differential analysis as of August 7 would indicate that leasing the equipment is financially more beneficial for Felix Company than selling it.