Question

Hudson Bay Corporation is considering leasing a new equipment. The lease lasts for 5 years. The lease calls for 5 payments of $42,000 per year with the first payment occurring immediately. The equipment would cost $195,000 to buy and would be straight-line depreciated to a zero salvage value over 5 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 6%. The corporate tax rate is 25%. What is the after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in year 2? (Hint: For this and following questions, review problem 6 in the practice problems of Chapter 21) $31,500 -$31,500 -$42,000 $27,500 -$41,250

Answer 1

-41250

(Difference = -31500-9750)

The cash flows are as below

	Buy			Lease
Year	Initial cost	Tax shield	Net CF	After tax payments
0	-195000		-195000
1		9750	9750	-31500
2		9750	9750	-31500
3		9750	9750	-31500
4		9750	9750	-31500
5		9750	9750	-31500

Book1 - Excel Sign in E - O X AutoSave on File Home D Draw : Page Layout Insert Formulas Data Review View Help Comments Tell me what you want to do I P Share E-A, = = e Insert Calibri -11 AA BIU - BA 9 27 0 = 0 3 General $ -% E Delete - Paste Conditional Format as Formatting Table Styles Cell Styles Format - . Sort & Find & Filter Select Editing Clipboard Font Alignment Number Cells B1- X for BC А Ε Buy Lease After tax payments Year Initial cost Tax shield 0 -195000 -25%*195000/5 =25%*195000/5 =25%*195000/5 =25%*195000/5 =25%*195000/5 Net CF ESUM(C3:03) =SUM(C4:04) =SUM(C5:05) =SUM(C6:06) =SUM(C7:07) =SUM(C8:08) --42000*(1-25%) =-42000*(1-25%) =-42000*(1-25%) =-42000*(1-25%) =-42000*(1-25%)