Primus Automation

Division, 2002
BLEMBA 25
SYNDICATE B
NURHUDA 29318323
MUHAMMAD IHSAN SALIM 29318374
M E I LY P R I L I A N I 2 9 3 1 8 4 7 1
R I KO R D I A S D. 2 9 3 1 8 3 9 1
V E N E S I A AY U 2 9 3 1 8 3 8 3
 PRIMUS AUTOMATION DIVISION
An innovative producer of world-class factory-automation
products and services, with operations in the US, Europe and
Asia.

OBJECTIVES
• Maintain leadership in the market share
• Increase sales by 15% a year
• Achieve its target for NI and Working Capital Turnover
STRATEGY
• Providing the most responsive customer service
• Attaining a strong share position in the high volume-
growing segments
• Offering leading-technology products
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 AVANTJET
C o r p o r a t e - J e t A i r c r a f t M a n u f a c t u r e r, C a p i t a l
Intensive, Marginally Profitable, Highly leveraged
• Trying to acquire an automation
system that will cut costs and
accelerate the company’s
production line
• CEO ordered a moratorium on any
capital expenditures that will
negatively affect the income
statement and balance sheet
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 LEASE EVALUATION
ON BOTH LESSOR AND LESSEE PERSPECTIVE

LESSOR PERSPECTIVE LESSEE PERSPECTIVE

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

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 1
BLEMBA 25
Question 1
W hy i s P r i m u s
A u to m at i o n co n s i d e r i n g
t h e l e a s e o f i t s fa c to r y -
a u to m at i o n syste m to
Ava nt J e t ?
 QUESTION 1
Why is Primus Automation considering the lease of
its factory-automation system to AvantJet?
• Primus needs to make the sale in order to meet the sales
budget for this year. The only way to make the sale is through
leasing, because in that case AvantJet would still be
interested in purchasing the system.
• AvantJet has encountered decline in its stock price and
worsening balance sheet due to economic recession. Income
Statement and Balance Sheet for the year does not look that
good, and buying an asset would make the balance sheet
even worse. That is why AvantJet is not very interested in
buying the system.
• Primus also has not been doing well lately and leasing could
help their sales budget out for that year.
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 2
BLEMBA 25
Question 2
H o w d i d To m B a u m a n n a n a l y z e
the problem of setting the lease -
financing terms? How does he
calculate NPV and internal rate
of return (IRR) for the lease and
borrow-and-buy alternatives?
Please complete case Exhibit 6.
 QUESTION 2
H o w d i d To m B a u m a n n a n a l y z e t h e p r o b l e m o f s e t t i n g t h e l e a s e - f i n a n c i n g t e r m s ?
How does he calculate NPV and internal rate of return (IRR) for the lease and
borrow-and-buy alternatives? Please complete case Exhibit 6.

Competitor Analysis:
Baumann had learned from industry newsletters that foreign manufacturers
sometimes exploited their allegedly lower costs of capital as a competitive
weapon in designing financing terms for their customers.
He planned to estimate the effective lease cost under their respective proposals
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 QUESTION 2
H o w d i d To m B a u m a n n a n a l y z e t h e p r o b l e m o f s e t t i n g t h e l e a s e - f i n a n c i n g t e r m s ?
How does he calculate NPV and internal rate of return (IRR) for the lease and
borrow-and-buy alternatives? Please complete case Exhibit 6.

Baumann Analysis:
• Tax Rates and Cost-of-Capital disparities between the lessor und lessee might be
critical drivers in any lease arrangement
• Baumann guessed that Avantjet had the same borrowing cost as Primus (9.5%)
but in a lower tax bracket.
• The effect lease has in the changing tax exposure
• Lower tax, higher NPV, lease financing less attractive
• The changing cost of debt rate which might affect the lease advantage over
borrowing.
• Cost of debt rises, lower NPV, lease financing more attractive
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 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%

QUESTION 2 After-tax cost of debt

NPV of loan (“borrow-and-buy”)
IRR of loan (“borrow-and-buy”)
6,27%
$469.273
6,27%
8,58%
$484.546
8,58%
9,50%
$663.800
9,50%
13,00%
$671.253
13,00%
EXHIBIT 6 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%
Summary Table of the Net Present Lease advantage over borrowing $14.556 $ 47.632 $ 11.937 $ 55.051

Value and Internal Rate of Return Leasing option #2 $160.003 $160.003 $160.003 $160.003
NPV of leasing option #2 $469.273 $450.901 $672.730 $635.927
for Four Tax and Cost-of-Capital IRR of lease 6,27% 6,27% 10,17% 10,17%
Lease advantage over borrowing $0 $ 33.645 $ (8.930) $ 35.326
Scenarios
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 $ (18.798) $ 25.997
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) $ 20.240 $ (28.930) $ 16.419
Faulhaber Gmbh $170.000 / 15% Res. Value
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
Honshu Heavy Industries $163.000 / 24% Res. Value
NPV of loan $438.036 $458.436 $624.641 $640.997
NPV of lease $478.063 $459.346 $685.330 $647.839
Add a footer IRR of lease 8,64% 8,64% 13,48% 13,48%
10
Lease advantage over borrowing $ (40.027) $ (911) $ (60.689) $ (6.842)
 Terms Under Hypothetical Buy-and-Borrow
and Leasing Strategies

QUESTION 2 Loan (“Buy-and-Borrow”)

5-year term loan
EXHIBIT 3 Payment in arrears
Equipment cost $715.000
Baumann and Team Develop Terms
Cash down payment $0
Under Hypothetical Buy-and-
Loan amount $715.000
Borrow and Leasing Strategies to
be offered to AvantJet to match the Lease Annual payments
competitor’s prices 5-year net lease (in advance)
Leasing option #1 $155.040
Leasing option #2 $160.003
Leasing option #3 $162.350
Leasing option #4 $164.760

Both Methods
Guaranteed residual value: 11,2729%
(required by Primus Equipment Finance Division)
Investment tax credit 0%
Depreciation 5-year MACRS
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 QUESTION 2
L O A N A M O R T I Z AT I O N TA B L E
U S I N G E X C E L F U N C T I O N P M T ( P r e Ta x A n n u a l R a t e ; Te r m ; To t a l P r i n c i p a l P V )

Loan Amortization Table

Year 1 2 3 4 5
Beginning Balance $ 715.000 $604.665 $479.987 $339.100 $179.898
Annual Payment $203.285 203.285 203.285 203.285 203.285 203.285
Interest Before Tax @ 13,00% 92.950 78.606 62.398 44.083 23.387
Principal Reduction 110.335 124.678 140.887 159.202 179.898
Ending Balance $604.665 $479.987 $339.100 $179.898 $0
Tax Rate 34,00%
Interest After Tax $61.347 $51.880 $41.183 $29.095 $15.435

Total Interest Paid $198.940

Total Principal Paid $715.000

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 QUESTION 2
EXHIBIT 4
Sample Calculation of the Present Value of Cash Outflows (Scenario B, Option 3)
Memo: Calculation of Residual Value Cash Flow
Tax rate: 34,00% Equipment cost: $ 715.000 Equipment cost $715.000
Pretax interest rate: 13,00% Lease payment: $ 162.350 Residual value (%) 11,2729%
Interest Five-Year Residual Residual value proceeds $80.601
3
Payment MACRS Depr. Depr. Cash Flow Loan Lease Less: tax expense $13.402
after Principal Depr. before Tax after Cash Cash Residual cash flow $67.199
2 2 4 5 6
Year Tax Payment Rate Tax Savings Tax Outflow Outflow
0 $0 $107.151
1 $61.347 $110.335 20,00% $143.000 ($48.620) $123.062 $107.151
Calculation of Tax Expense
2 $51.880 $124.678 32,00% $228.800 ($77.792) $98.767 $107.151 Market value $80.601
3 $41.183 $140.887 19,20% $137.280 ($46.675) $135.394 $107.151 Less net book value $41.184
4 $29.095 $159.202 11,52% $82.368 ($28.005) $160.292 $107.151
5 $15.435 $179.898 11,52% $82.368 ($28.005) ($67.199) $100.129 $0
Gain on sale $39.417
Sum $198.940 $715.000 94,24% $673.816 ($229.097) ($67.199) $617.643 $535.755 Tax expense $13.402
NPV $484.546 $457.515
Calculation of Net Book Value
This table illustrates the calculation of net present value (NPV) for the two methods Equipment cost $715.000
of equipment financing: the loan financing alternative (also called buy-and-borrow) Depreciation before tax $673.816
and the lease financing. Because these cash flows are net outflows or expenses, Net book value $41.184
the alternative with the lower net present value will be more attractive to the
customer.
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 QUESTION 2
EXHIBIT 5 Sample Calculation of the Internal Rate of Return
for Lease Financing (Scenario B, Option 3)

This table illustrates the calculation of the Lease

internal rate of return (IRR) associated with Lease Forgone Tax Forgone Initial Payment
lease financing. The IRR is the effective Payment Savings Residual Value Purchase Less
after-tax cost of the lease financing and is after Associated with after Price Incremental
useful for comparison with the cost of Year Tax 2 Depreciation 2 Tax 2 Saved Cash Flow
alternative forms of financing. Because this 0 ($107.151) $715.000 $607.849
is a calculation based on costs to the 1 ($107.151) ($48.620) ($155.771)
customer, a lower IRR will be more attractive 2 ($107.151) ($77.792) ($184.943)
to the customer 3 ($107.151) ($46.675) ($153.826)
4 ($107.151) ($28.005) ($135.156)
5 $0 ($28.005) ($67.199) ($95.204)
Sum ($535.755) ($229.097) ($67.199) $715.000 ($117.052)
IRR 6,72%

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 3
BLEMBA 25
Question 3
How are Faulhaber and Honshu
Heavy Industries using their
leasing plans?
 QUESTION 3
How are Faulhaber and Honshu Heavy Industries using their leasing plans?

Faulhaber and Honshu are both making their leasing plans look attractive than
Primus.
• In all Honshu’s options, either there is a very high NPV, which is unattractive to a buyer,
or there is a strong financial disadvantage to leasing over buying. When presented with
these numbers, a customer would be likely to consider buying rather than leasing.
• Faulhaber’s option is less attractive than all Primus’s option (option 1, 2, 3 and 4)
• However: Baumann had learned from industry newsletters that foreign manufacturers
sometimes exploited their allegedly lower costs of capital as a competitive weapon in
designing financing terms for their customers. Both Competitors have Higher NPV in
their perspective means more profit to them compare to Primus (9,5% Cost of Debt ,
34% Tax)
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 QUESTION 3
How are Faulhaber and Honshu Heavy Industries using their leasing plans ?
L E A S E V S . L O A N S C E N A R I O S O N AVA N T J E T ( L E S S E ) P E R S P E C T I V E
2001 Tax Rate 49,00%
2001 Pre-tax Interest Rate 13,00%
Primus 1 Primus 2 Primus 3 Primus 4 Faulhaber Honshu
Loan NPV $390.240 $390.240 $390.240 $390.240 $403.789 $367.544
Lease NPV $349.151 $360.328 $365.613 $371.040 $382.841 $367.077
Loan IRR 6,63% 6,63% 6,63% 6,63% 6,63% 6,63%
Lease IRR 4,00% 4,71% 5,05% 5,40% 5,39% 6,60%
Savings $ 41.089 $ 29.912 $ 24.627 $ 19.200 $ 20.948 $ 467

PRIMUS FAULHABER HONSHU

LEASE VS. LOAN SCENARIOS ON
9,5% / 34% 5% / 34% 5% / 34%
LESSOR PERSPECTIVE
Loan NPV $469.273 $458.800 $445.502
Assumption:
Lease NPV $476.156 $526.284 $504.613
Competitor’s Cost of Capital 5%,
Loan IRR 6,27% 3,30% 3,30%
Same Tax Rate
Lease IRR 6,72% 7,13% 6,75%
Savings $ (6.884) $ (67.484) $ (59.112)
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 4
BLEMBA 25
Question 4
What lease terms should
Baumann recommend? How
s h o u l d P r i m u s ’s s a l e s a n d l e a s i n g
divisions structure the terms of
the deal with Avantjet? How
would you approach the
negotiations with Avantjet?
 QUESTION 4
W h a t l e a s e t e r m s s h o u l d B a u m a n n r e c o m m e n d ? H o w s h o u l d P r i m u s ’s s a l e s a n d
leasing divisions structure the terms of the deal with Avantjet? How would you
approach the negotiations with Avantjet?
All suggested lease terms must be lower in cost than proposals from Honshu and Faulhaber and the
cost of the loan alternative. The lessee’s decision rule is to choose the loan or lease depending on
which one has the lower NPV or IRR based on their perspective
• Option 1: It has lower Lease NPV and IRR in the Lessee Perspective, Superior Pricing compare to Competitor
but low margin for Primus (Not Optimum)
• Option 2: It has lower Lease NPV and IRR in the Lessee Perspective, Superior Pricing compare to Competitor
but low margin for Primus (Not Optimum)
• Option 4: Lease IRR is higher than Faulhaber and Lease NPV is higher than Honshu which are undesirable in
the Lessee Perspective
Lease OPTION 3 is recommended because it superior pricing from competitors and give positive
NPV and IRR for Primus. Realistic to be offered to the AvantJet with more attractive NPV and IRR
than Borrow and Buy (Loan) option. However, Baumann Division should ensure 11,2729% Residual
Value, in order to increase gain on resale after Leasing Contract Period is ended.
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 QUESTION 4
W h a t l e a s e t e r m s s h o u l d B a u m a n n r e c o m m e n d ? H o w s h o u l d P r i m u s ’s s a l e s a n d
leasing divisions structure the terms of the deal with Avantjet? How would you
approach the negotiations with Avantjet?

After Tax Cost Minimum

Minimum / Baseline Lease Rate Quote: of Debt 6,27% 156.766 Lease Rate
• $156.766 in order to match Sale Price Sale Price
$715.000 at the first year 15% Margin 715.000,00 715.000 NPV
Year 1 156.766
• By comparing NPV of Sale Price and NPV
Year 2 156.766
of Lease Option. Using regression
Year 3 156.766
analysis to get the Minimum Lease Rate
Year 4 156.766
with NPV at least $715.000
Year 5 237.367 Include Residual Value
• In order to meet the target sales, the
Quote Price of Lease Rate should no
lower than $156.766

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 THANK YOU
Primus Automation
Division, 2002
BLEMBA 25
SYNDICATE B
NURHUDA 29318323
MUHAMMAD IHSAN SALIM 29318374
M E I LY P R I L I A N I 2 9 3 1 8 4 7 1
R I KO R D I A S D. 2 9 3 1 8 3 9 1
V E N E S I A AY U 2 9 3 1 8 3 8 3