Primus Automation

29318028 - Dani Dzun Nadhir

29318111 - Faradina Az-Zahra
29318081 - Irvito Adhy Sanjaya
29318137 - Rayendra Yustian Dvinanda
29318086 - Sari Intan Pratiwi
 Primus Automation
Primus Automation, a division of a large, worldwide manufacturing and services firm,
was an innovative producer of world-class factory-automation products and services, with
operations in several continents

U.S.A Europe Asia

 Primus Automation
Products
● Programmable controllers,
numerical controls
● Industrial computers
● Manufacturing software
● Factory automation systems
● Data communication
networks.
Objectives
● Maintain leadership in market
share
● Increase sales by 15% a year
● Achieve its targets for net
income and working capital
turnover
 Asset Financing Approaches

● The customer could purchase a system with cash or with borrowed funds, either unsecured or
collateralized by the equipment.
● The firm could acquire the equipment through a conditional sale in which the title would pass to the
firm upon the receipt of the final payment.

● The customer could lease the equipment in one of two ways:

○ via a cancelable operating lease

○ via a noncancelable financial capital lease

Avantjet

Determined to get an automation system

to cut costs and accelerate his company’s
production line.

Options: borrow, lease, acquire through

conditional sale.

Aircraft Industry
Capital vs Operating Lease Theory

Capital Lease Operating Lease

the lessee would be required to the lease payments would be treated as

depreciate the equipment by showing it an ordinary expense, deductible from
as an asset and a liability on its balance taxable income, the leased property
sheet, could not deduct the lease would not appear on the lessee’s balance
payment from its income taxes and at the sheet and would revert to the lessor.
end of the lease, the lessee retained
ownership and bore the risk of early
changes in the asset’s value.
Problem
Avantjet’s purchase of a factory-automation system from Primus Automation Division had been put on an
indefinite hold due to declining stock price and worsening balance sheet after economic recession.

CRITICAL for the Year’s Sales Budget

Feared that previous competitor Explored creative financing options

renew their sales proposal and won such as leasing to remove Aventjet’s
despite already winning reluctance to proceed

WHAT KIND OF LEASING MODEL WOULD BE LEAST

COSTLY AND BEST OPTION FOR AVANTJET?
Analysis
Baumann has elected to assess four lease payment
alternatives, as described in case Exhibit 3, against
four sets of assumptions about Avantjet’s tax
exposure and pretax cost of debt. Case Exhibit 6
presents a worked-out set of calculations for
Scenario A, and leaves the student to complete the
analysis for the other three scenarios. Exhibit
provides a completed table.

The completed work yields a number of insights. The

first is how dramatically the lease’s attractiveness to
a customer can vary depending on the customer’s
tax rate and cost of debt. The instructor can ask the
students to consider three sets of comparisons:

·
Analysis
● Tax exposure. A comparison of Scenarios A
(tax rate of 34%) and C (tax rate of 0%) shows a
sizable increase in the cost of financing as
Avantjet’s tax exposure declines—on average
more than $200,000 in NPV cost, or 320 to 450
basis points. This is an object illustration of the
effect of financing tax shields.
● Cost of debt. A comparison of Scenarios A
(9.5% cost) and B (13% cost) reveals that as
Avantjet’s cost of debt rises, the lease financing
becomes more attractive.
● Interaction of tax exposure and cost of debt.
A comparison of Scenarios A and D shows that
with the loss of tax shields and more expensive
debt, lease financing generally dominates the
borrow-and-buy alternative.
Analysis
The table also reveals that all of Primus’s leasing options
are superior to Honshu’s lease proposal under all four
scenarios. Primus’s lease payment schemes 1, 2, and 3
dominate Faulhaber on an IRR basis under all the
scenarios; Baumann might consider tinkering slightly with
the lease terms to dominate this competitor.

Focusing on IRR costs to Avantjet obscures an important

competitive advantage: the comparatively cheaper
purchase price of the Primus system. This price
advantage could permit Primus to ask the annual lease
payment of ($162,350) yet meet its minimum required
rate of return of 6.72%, assuming a tax rate of 34% and a
cost of debt of 9.5%. If Avantjet is truly cash constrained,
and if the Primus system is both cheaper and genuinely
comparable to the others, then Avantjet may accept
leasing option 3.
Solution

Many of the considerations that surround making a recommendation have been surveyed
above. The feasibility test for all suggested lease terms is that they must be lower in cost
than proposals from Honshu and Faulhaber and the cost of the buy-and-borrow alternative,
yet they must meet or exceed the risk-adjusted, required rate of return as seen by Primus
(6.72%). In short, Tom Baumann faces a constrained optimization problem. He must first
assess what kind of customer Avantjet is (i.e., in terms of tax exposure and cost of debt) and
then tailor a winning proposal within the constraints.

In essence, this is a problem of financial engineering: One lease proposal does not fit all
scenarios. Specifically, we should see that to win the deal and meet the capital cost hurdle,
Primus should offer the terms in the following four scenarios
 Solution
Based on the analysis, Primus Automation’s IRR and NPV for all options and scenarios are
better than Honshu which means leaving Faulhaber as the only competitor in consideration.

Faulhaber’s scenario A and C has a better NPV in loan than for lease which means for leasing, it
has a negative results. Based on the options that Primus has, almost all options shows better
results.

However, for option #4 the differences are not that big which makes it possible for Faulhaber to
be chosen. For option #1 the differences are too big which cause Primus to spend more cost
and the lease of Avantjet become too low when it can be higher. At the same time, Primus can
win over Faulhaber with less cost using option #2 and #3.

If we look at the result from scenario B and D which has more positive result for leasing, option
#3 is better than #2 because the lease price is still competitive for Avantjet (not too low) which
makes the cost for Primus is not too big as well, but still win over Faulhaber.
Solution

In conclusion with all scenarios considerated, it would be better for Primus Automation to
choose option #3 for leasing the Avantjet because then Primus will win over competitors,
namely Faulhaber, and Honshu, while at the same time not using quite a big amount of cost
and still being able to lease the avantjet with competitive/normal (not too low) price.