You Are Considering Purchasing Industrial Equipment to Expand One of Your

Essay

You are considering purchasing industrial equipment to expand one of your production lines. The equipment
costs $100,000 and has an estimated service life of 6 years. Assuming that the equipment will be financed
entirely from your business-retained earnings (equity funds), a fellow engineer has calculated the expected
after tax cash flows, including the salvage value, at the end of its project life are as follows: Now you are pondering the possibility of financing the entire amount by borrowing from a local bank at 12%
interest. You can make an arrangement to pay only the interest each year over the project period by deferring
the principal payment until the end of 6 years. Your firm's interest rate is also 12%. The expected marginal
income tax rate over the project period is known to be 40%. What is the amount of economic gain (or loss) in
present worth by using debt financing over equity financing?