Case 33: Hasbro

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Leasing versus Buying

Hasbro, Inc., is a multinational parent company who is in the primary business of designing, manufacturing, and marketing toys, games, puzzles, etc. Their subsidiary companies include such household names as Parker Brothers, Milton Bradely, Tonka, and Playskool. These companies produce some of the most easily recognized products in the world: Monopoly, Mr. Potato Head, G.I. Joe, Scrabble, East Bake Ovens, Play Doh, and Transformers, to name a few.

Hasbro is currently trying to pick-up ground in the doll market by directly competing with Mattel's Barbie, a front runner in the doll market segment for decades. To do so, Hasbro has proposed the sale of their own teenage doll, Maxie. To produce Maxie, Hasbro must acquire several new pieces of equipment.

As part of the production process, Hasbro currently occupies certain manufacturing facilities and sales offices and uses certain equipment under various operating leases. Now that they need to acquire more machinery, they must decide whether to buy or lease the new equipment.

Hasbro can purchase the machinery for $30,000 by financing over a five year period at 8% interest. The corresponding annual payment would be $7,514. Buying the machinery has an advantage in that the machine can be depreciated using the MACRS five year recovery system. Depreciation rates are given below.

Year	Percent that can be Depreciated
1	20
2	32
3	19
4	12
5	12

The drawback to purchasing the machinery, however, is that the maintenance duties are borne by the owner. To maintain the machinery will cost Hasbro $1,000 each year for five years.

If Hasbro decides to lease the machinery, they will have to pay the lessor $7,000 per year for the next five years. As with most operating leases, the lessor will pay for all maintenance necessary. At the end of the five year period, Hasbro will have the option to buy the machinery at a cost of $6,000. The tax rate for Hasbro is 40%.

Questions

Find the after-tax cash flows associated with the lease payments. Assume Hasbro will agree to purchase the machinery at the end of the five year period for the agreed upon $6,000.
If the machinery is purchased, the interest paid from financing it is tax deductible. Since this is the case, find the amount of interest paid each year.
Depreciation is also tax deductible if the machinery is purchased. Calculate the depreciation expenses over the five year period.
Knowing that depreciation, interest expenses, and maintenance costs are tax deductible, calculate the total tax shield associated with purchasing the machinery.
What are the total net after-tax cash outflows associated with purchasing the machinery?
Using your answers from questions 1 and 5, should Hasbro lease or buy the machinery? (i.e. What is the present value of the costs associated with both options?)
In general, what are the advantages and disadvantages to leasing?

In question 1, we assumed Hasbro would purchase the machinery for $6,000 at the end of the five year lease period. In practice, Hasbro will want to wait the full five years before they make that decision. What will their decision be based on at that time? That is, if Hasbro decides to lease the machinery, what factors will determine their decision of whether or not to buy the machinery at the end of the lease?

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