Question

Recovery year 14% Percentage by recovery year“ 3 years 5 years 7 years 10 years 33% 20% 10% 45% 32% 25% 18% 15% 19% 18% 14% 12% 12% 12% 12% 9% 9% 8% 9% 7% 6% 7% voor Aw 9% 5% 4% 6% 10 6% 4% Totals 100% 100% 100% 100% These percentages have been rounded to the nearest whole percent to simplify

Lease versus purchase

JLB Corporation is attempting to determine whether to lease or purchase research equipment. The firm is in the 21​% tax​ bracket, and its​ after-tax cost of debt is currently 9​%. The terms of the lease and of the purchase are as​ follows:
Lease : Annual​ end-of-year lease payments of ​$31,000 are required over the​ 3-year life of the lease. All maintenance costs will be paid by the​ lessor; insurance and other costs will be borne by the lessee. The lessee will exercise its option to purchase the asset for $7,000

at termination of the lease. Ignore any future tax benefit associated with the purchase of the equipment at the end of year 3 under the lease option.
Purchase : The research​ equipment, costing $75,000
​,can be financed entirely with a 13​% loan requiring annual​ end-of-year payments of ​$31,764 for 3 years. The firm in this case will depreciate the equipment under MACRS using a​ 3-year recovery period. The firm will pay ​$2,600 per year for a service contract that covers all maintenance​ costs; insurance and other costs will be borne by the firm. The firm plans to keep the equipment and use it beyond its​ 3-year recovery period. 
 
a.Calculate the ​after-tax cash outflows associated with each alternative
​(Hint​: Because insurance and other costs are borne by the firm under both​ alternatives, those costs can be ignored​ here.)

b.Calculate the present value of each cash outflow​ stream, using the​ after-tax cost of debt.

c.Which alternativelong lease or purchaselong would you​ recommend? ​ Why?

Answer 1

Lease 0 Yr Lease charges Less: tax shield Option to purchase Total Cash Flow 1 2 3 31000 31000 31000 -6510 -6510 -6510 7000 24490 24490 31490 PV @ 9% $67,396.69 Buy After tax cost of debt Tax rate 9% 21% 0 Yr Opening loan Interest Loan Repayment Principal repayment Closing Loan 1 2 3 75000 52986 28110 9750 6888 3654 31764 31764 31764 22014 24876 28110 52986 28110 1 0 Yr Depreciation rate Depreciation 1 2 3 33% 45% 15% 24750 33750 11250 Yr 0 Loan repayment Service contract Less: tax shield on interest Less: tax shield on depreciation Total Cash Flow 1 2 3 31764 31764 31764 2600 2600 2600 -2048 -1447 -767 -5198 -7088 -2363 27119 25830 31234 PV @ 9% $70,738.85 Since NPV of lease is cheaper, we should go for that option