Question

An asset has an installed cost of $250,000, a life of 5 years, a CCA rate of 30%, and a salvage value of $5,000. This asset can be leased for 5 years at a rate of $50,000 per year, payable at the beginning of each year. The lessee's marginal tax rate is 35% and borrowing cost is 10%. What is the net advantage to leasing for the lessee? Round your answer to the nearest dollar.

$33,839

$52,652

$37,488

-$43,613

$49,548

Answer 1

Asset cost = $250,000 Life = 5 Years CCA rate = 30% Salvage value = $5,000 Leasing life = 5 years Leasing amount = $50,000 per year Leasing payable at = Begiming of the year Marginal tax rate= 35% Borrowing cost = 10% - - - - - - - - - - - - - - - - After-tax cost Before tax borrowing cost X(1 - Tax rate) = 10%x(1-35%) = 16.50% (1-Tax rate) Step 1: After-tax lease payment After-tax lease payment = Pretax lease payment = $50,000x (1-35%) = $32,500 Therefore, the after-tax lease payment is $32,500 Step 2: Present value of after-tax lease payment (Beginning of the year - Annuity due) After-tax lease payment 11 - X – Present value = After-tax lease payment (1+ After-tax costumber of periods After-tax cost x (1 + After-tax cost) = $32,500 x- (1 +6.50%) - *(1+6.50%) 6.50% $ 143,838.45 Therefore, the present value of after-tax lease payment is $143, 838.45 Step 3: Present value of CCA tax shield (PVCCA)

Cost of asset x CCA rate Tax rate CCA rate + After-tax cost (1 + 0.5 x After-tax cost 1+After-tax cost Salvage value x CCA ratex Tax rate CCA rate + After-tax cost Present value = CCA Tax shield (1 + After-tax cost) $250,000 * 30% * 35% (1 + 0.5x6.50% 30% + 6.50% 1+6.50% $50,000 * 30% × 35% _ 1 30% +6.50% (1+6.50%) (($71,917.81)x (0.969483568075117) 1-($1,438.36)(0.7298808365210) = $68,673.30 Therefore, the present value of CCA tax shield is $68, 673.30 Step 3: Present value of Salvage value Present value = Salvage value Salvage value (1+ After-tax costumber of periods $50,000 (1 +6.50%) = $3,649.40 Therefore, the present value of salvage value is $3,649.40 Step 4: Net advantage to leasing (NAL) NAL = Cost of an asset - PV of after-tax lease payment - PVCA - PV of salvage = $250,000 - $143.838.45-568, 673.30 - $3,649.40 = $250,000-$216.161.15 = $33,838.85 or $33,839 Rounded upto whole dollar Therefore, the net advantage to leasing (NAL) is $33,839