I have this case study to do and I have done my spreadsheet but I am not sure if it is done correctly. Can you complete the spreadsheet attached based on the Biotech Services, Inc. case that is written out below? Also the instructions for the case are written below, so in order to complete the spread sheet, read the case first and then the case instructions (there are some changes to the numbers in the case that are stated in the instructions that need to be used in order to complete the spreadsheet). Also can you answer questions 1-9 that are at the end of the case (below)?? Case 3 Biotech Services, Inc. Lease Versus Buy Decision Case Instructions Due Date: Thursday, October 25, 8:00 am. The case write up can be found in the course notes (starting on the Notes&Cases.pdf file page 192). It consists of a description of the situation, followed by nine questions. You are to complete the following: 1. Build an Excel 2007 or 2010 worksheet to analyze the quantitative aspects of the case. Begin by opening the BiotechStarter.xlsx worksheet and then modify it as necessary to do the analysis. Use the conventions and style of the other worksheets used in the course. Incorporate the ACRS depreciation rates (described in question #2 on page 178 at the end of the case) into your worksheet calculations. Note that on your worksheet the end of year four is the same as the beginning of year five in the case; hence the book value at the end of year four on the worksheet is what the case states it should be at the beginning of year five. Remember to: ? Complete the first 61 rows of the worksheet using formulas similar to those used in class and the Lease Example worksheet. Show the calculation for the cost of owning using both the loan amortization table (A27:E39) and the alternate calculation (M24:N39). The loan amount is $200,000. ? Assume that the market value of the equipment (if purchased) at the end of year four is estimated to be $25,000, not the amount implied by the case write-up. Also note that there are a total of five lease payments for the lease option. ? Be sure to read the comments attached to all cells with a red flag! ? Assume that if the equipment is purchased that it will be depreciated for tax purposes using the ACRS rates given in the spreadsheet. ? In completing the spreadsheet, use equations to link output variable cells with input parameter cells. Note that cells with ?XXXXXX? need to be replaced with either formulas or blank/empty cell entries; the spreadsheet is meant to accommodate a generic lease-buy analysis with up to ten years of cash flows so you may leave cells in rows beyond the life of this project blank. ? Perform the tasks and answer the questions listed on the spreadsheet in the space provided. ? There are nine questions at the end of the case write-up. You will not turn in the written answers to these questions, but you should be prepared to answer questions 1-7 if asked on the in-class case quiz. Lease versus Purchase Biotech Services, Inc. Over the past few years, Florida state officials have become increasingly aware of an extremely serious problem-the potential pollution of groundwater by toxic chemicals, improperly disposed wastes, and malfunctioning septic systems. There are no signs that the main water source underlying the state, the Floridian aquifer, has yet been contaminated. However, there are many indications that agricultural chemicals used in citrus groves, abandoned underground gasoline tanks, and unregulated landfills have caused extensive but localized contamination of wells that tap shallower water-bearing strata. To combat this growing problem, strict environmental regulations have been enacted and are being implemented throughout Florida. As a result of the new laws, soil and water testing demands have put a strain on laboratories' ability to provide prompt test results for a broad spectrum of possible pollutants. Biotech Services, Inc., has profited from the surge in demand for water testing. but the capabilities of its laboratory are strained to the limit. Hence, a significant amount of business has been turned away because of an inability to perform the tests and provide analyses on a timely basis. Elizabeth Jensen, Biotech's founder and president, believed that the acquisition of some new, specialized testing equipment would give the company the analytical capability to service a larger share of the emerging market. Given Biotech's reputation as a leader in the field of environmental monitoring and testing. she was confident that the company could capture a major share of the market if it had the ability to provide the rapid results that would be possible with the new equipment. In the formal capital budgeting analysis of the proposed acquisition, the internal rate of return (IRR) of the project was found to be 26 percent versus a required return of 11 percent. Biotech uses an after-tax cost of capital of 11 percent for relatively low-risk projects and 15 percent for projects with above average risk, so this normal-risk project passed with flying colors. Also, a discounted payback of slightly more than two years indicated that the project was a good investment. The test equipment has an invoice price of $200,000, including delivery and installation charges. Biotech calculates depreciation as specified by the accelerated cost recovery system (ACRS) for a five-year asset, and its effective tax rate is 40 percent. The manufacturer of the equipment will provide a contract for maintenance and service for $15,000 per year, payable in advance for the coming year, if Biotech decides to buy the equipment. Currently the company has sufficient capital in the form of temporary investments in marketable securities to pay cash for the equipment. Jensen does not want to go to the bank for a loan at this time because interest rates are not particularly attractive. She estimates that the interest rate on a fully secured loan for $215,000 would be 12 percent. Hence, she has decided to draw down the securities portfolio and pay cash for the equipment if it is purchased. The maker of the equipment, Spectronics Engineering, has offered to lease the equipment to Biotech Services for $40,000 upon delivery and installation plus four additional lease payments of $40,000 at the end of each of the next four years. This price includes a service contract under which the equipment will be maintained in good. working order. Actually, the expected life of the testing equipment is eight years, at which time it should have a zero market value. At the end of the fourth year, though, the resale value should be substantially in excess of zero. Jensen generally assumes a salvage value equal to the equipment's book value at any point in time, but she is concerned that the difference between the eight-year economic life and the five-year ACRS life might invalidate this assumption. Regardless of whether the equipment is purchased or leased, Jensen does not intend to use it for more than four years. In four years, Biotech's current lease will expire. Land has already been acquired on which to construct a larger facility, which should be ready for occupancy at the expiration of the present lease. The new laboratory will be designed to enable Biotech to use several new analytical processes that are currently unavailable to it, including one that will duplicate all tests of the equipment now being considered. Hence, this project is viewed as a "bridge" to serve only until the permanent equipment can become operational in the new laboratory four years from now. Elizabeth Jensen has always made the final decisions on all lease versus purchase considerations. The actual calculation of the relevant data, however, is the task of Biotech's treasurer, Beverly Brennon. Traditionally, Jensen's method of evaluating such a decision has been to calculate the present value cost of lease payments versus the present value of total charges if the equipment is purchased. However, in a recent decision concerning a matter similar to the one presently being considered, Jensen and Brennon got into a heated discussion about the appropriate discount rate to use in determining the present value costs of leasing and of purchasing. The following points of view were expressed: 1. Jensen argued that the discount rate should be the firm's weighted average cost of capital. A lease versus purchase decision is, in effect, a capital budgeting decision, and, as such, it should be evaluated at the company's cost of capital. In other words, one method or the other will provide a cash saving in any year. The dollars saved using the most advantageous method will be invested to yield the firm's cost of capital. Therefore, the average cost of capital is the appropriate opportunity rate to use in evaluating leasing versus purchasing decisions. 2. Brennan, on the other hand, believed that the cash flows generated in a lease versus purchase situation are more certain than are the cash flows generated by the firm's average projects. Consequently, these cash flows should be discounted at a lower rate because of their lower risk. At the present time the firm's cost of secured debt reflects the lowest risk rate to Biotech Services. Therefore, 12 percent should be used as the discount rate in the lease versus purchase decision. To settle the debate over the previous decision, Jensen and Brennon asked their accountants to review the situation and to advise them on which discount rate was appropriate. This led to an even more confused situation as their accountants, Marion and Shirley Boynton, could not agree among themselves as to the appropriate discount rate. Marion, on the one hand, agreed with Jensen that the discount rate should be the average cost of capital, but on the grounds that leasing is simply an alternative to other means of financing. Since leasing is a substitute for "financing," which is a mix of debt and equity, leasing saves the cost of other financing; this cost is the firm's weighted average cost of capital. Shirley, on the other hand, felt that none of the discount rates mentioned so far adequately accounted for the tax effects inherent in any capital budgeting decision, and she suggested the use of an after-tax cost of secured debt. In the last lease versus purchase decision, the average cost of capital (11 percent) was used, but now Jensen is uncertain about the validity of this procedure. She is inclined toward Shirley Boynton's alternative, but she wonders if it would be appropriate to use a low-risk discount rate for evaluating all cash flows in the analysis. Jensen is particularly concerned about the risk of the differential cash flows on the lease versus purchase decision, as compared to the risk of the expected salvage value. While the company is almost certain of the flows required under the lease or the tax shelters received under the purchase, the salvage value at -the end of the fourth year is relatively uncertain, having a distribution of possible out- comes that makes its risk comparable to that of the average risk project undertaken by the firm. She is also concerned that using a discount rate based on the after-tax cost of a secured loan might be inappropriate when the funds used to purchase the equipment would come from internal corporate sources. Perhaps the cost of equity capital also deserves consideration, because the funds could be paid to the stockholders and invested by them to earn the cost of equity. Questions: 1. The conventional format for analyzing lease versus purchase decisions assumes that money to buy the equipment will be obtained by borrowing. In this case, though, Biotech has sufficient internally generated capital, held in the form of marketable securities, to buy the equipment outright. Does this situation cause any difficulties in structuring the analysis? 2. Set up a worksheet and calculate the comparative cost of leasing versus buying the new testing equipment. (Note: the equipment must be depreciated over six years by the ACRS provisions. The following depreciation rates are specified by the IRS: Year I, 20 percent; Year 2, 32 percent; Year 3, 19 percent; Year 4, 12 percent; Year 5, 11 percent; Year 6,6 percent. Also, assume that if the decision is made to purchase the machine, it will be sold for its book value at the start of Year 5 rather than at the end of Year 4. Otherwise, the Year 4 depreciation could not be taken.) 3. Justify the discount rate or rates that you use in the calculation process. 4. Can you suggest any other way to find a salvage value for the equipment at the end of Year 4 that might be more realistic than merely assuming that it equals the book value? (Hint: See the discussion of "Discounted Service Potential in case 17.) What would happen to the decision indicated by your analysis in Question 2 if you were to use this revised value for the salvage value? 5. Based on the information given in the case, would you classify this lease as a financial lease or as an operating lease? Why? If Biotech Services leased the equipment, and you were told that its value ( $200,000) is a substantial sum of money in relation to Biotech's total assets, would you expect the transaction to cause problems for out- side financial analysts? If it would cause problems, how might analysts overcome them? 6. Should Biotech Services, Inc. lease or purchase the equipment? 7. Now assume that Biotech will definitely use the equipment for its full eight-year life (there is a long-term contract with the Florida Department of Environmental Regulation covering the whole period). However, the equipment manufacturer is only willing to lease it for four years with an option to buy it for its fair market value at the end of the fourth year. This value at Year 4 could turn out to be close to zero, or it could be exceptionally high, but your "best guess" is still the book value. How would this modification of the problem change your analysis of the lease versus purchase decision? Clearly, this modification has introduced more uncertainty into the problem. Has it also increased--or has it decreased-the risk associated with the project? 8. In some instances, a leasing company might offer a contract involving a cost less than the debt cost the firm would incur if it were to attempt to finance the purchase with a loan. If the equipment represented a significant addition to the firm's assets, could this affect its overall cost of capital? 9. Suppose Biotech Services had been operating at a loss and therefore had tax loss carry-forwards that caused the company to project that its income tax rate would be zero for the next few years. How would this change alter the analysis and your recommendation?
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