Question

School [2] Financial Lease (20 points) Your firm is considering leasing dedicated servers for cloud computing payments of $50,000 each with the first payment occurring immediately. The equi $240,000 to buy and would be straight-line depreciated to zero salvage value can borrow at 9% and the tax rate is 35%. Calculate the PV of leasing and the P alternatively, the "lease PV". Questions: ual pment would cost The firm V of buying or, The lease calls for six ann in five years. Show after-tax interest rate Show annual depreciation charges Show tax shield on lease payments Show PV of leasing Show PV of buying Show Lease PV PV of leasing - PV of buying PV (leasing- buying) .Should the company lease or buy? Why? 4

Answer 1

Cost of the servers	240000
Annual lease payments	50000
Tax rate	35%
Interest rate	9%
After tax interest rate = 9%*(1-35%) =	5.85%
	0	1	2	3	4	5
Annual depreciation schedule
Annual depreciation		48000	48000	48000	48000	48000
Annual lease payments	50000	50000	50000	50000	50000	50000
Leasing - Cash-flows:
Lease payments	50000	50000	50000	50000	50000	50000
Tax shield on lease payments	17500	17500	17500	17500	17500	17500
Cash flow	-32500	-32500	-32500	-32500	-32500	-32500
PVIF at 5.85%	1	0.94473	0.89252	0.84319	0.79659	0.75257
PV at 5.85%	-32500	-30704	-29007	-27404	-25889	-24458
PV of lease	-169962
Ownership- Cash-flows:
Cost of the drilling machine	-240000
Depreciation tax shield		16800	16800	16800	16800	16800
Cash flow	-240000	16800	16800	16800	16800	16800
PVIF at 5.85%	1	0.94473	0.89252	0.84319	0.79659	0.75257
PV at 5.85%	-240000	15872	14994	14166	13383	12643
PV of ownership	-168943
PV of owning the asset-PV of leasing of the asset	1020
		`
Lease PV:
Lease payments	-50000	-50000	-50000	-50000	-50000	-50000
Tax shield on lease payments	17500	17500	17500	17500	17500	17500
Cost of the asset	240000
Depreciation tax shield		-16800	-16800	-16800	-16800	-16800
Cash flows	207500	-49300	-49300	-49300	-49300	-49300
PVIF at 5.85%	1	0.94473	0.89252	0.84319	0.79659	0.75257
PV at 5.85%	207500	-46575	-44001	-41569	-39272	-37102
Lease PV	-1020
DECISION:
As the Lease PV is negative, the asset should be bought.