Question

kind provide solution to this leasing question

1. Wolfson Corporation has decided to purchase a new machine that costs $5.1 million. The machine will be depreciated on a straight-line basis and will be worthless after four years. The corporate tax rate is 35 percent. The Sur Bank has offered Wolfson a four-year loan for $5.1 million. The repayment schedule is four yearly principal repayments of $1,275,000 and an interest charge of 9 percent on the outstanding balance of the loan at the beginning of each year. Both principal repayments and interest are due at the end of each year. Cal Leasing Corporation offers to lease the same machine to Wolfson. Lease payments of $1.5 million per year are due at the end of each of the four years of the lease. Should Wolfson lease the machine or buy it with bank financing?

Answer 1

Cost of buying =   -5100000      
Annual lease payment=   -1500000      
After tax lease payment = 1500000*(1-35%)=   -1001000      
Borrowing rate is cost of capital that is 9% or 0.09. After tax rate (i) = 0.09*(1-35%)=   0.0585      
Time (n)=   4      
          
Present value of Lease payment=    Annual lease cost * (1- (1/(1+r)^n))/r      
-1001000*(1-(1/((1+0.0585)^4)))/0.0585          
-3480517.743          
          
Depreciation tax benefit per year = Cost of asset/no of years* tax rate          
5100000/4*35%=   446250      
Present value of tax benefit of depreciation =          
446250*(1-(1/((1+0.0585)^4)))/0.0585          
1551629.414          
Total cost of buying = cost of machine + tax benefit of depreciation          
-5100000+1551629.414=   -3548370.586      
Net advantage to leasing = Present value of lease cost - Present value of buying Cost           
-3480517.743   -(   -3548370.586   )
67852.84297          
          
So Net advantage to Lease is    $67,852.84. Company should lease the Machine