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 NPV of the lease relative to the purchase if the asset had a pretax salvage value of $7,000 (ignoring any possible risk differences)? -$16,474.13 -$13,368.21 -$10,508.25 $3,477.80 $8,427.96

Answer 1

Lease payment Tax saving on lease Lost dep. Tax shield Equipment cost Total xPVIF @ 4.50% Present value Year 0 11 12 13 14 15 $ (42,000) $ (42,000) $ (42,000) $ (42,000) $ (42,000) $ 10,500 $ 10,500 $ 10,500 $ 10,500 $ 10,500 $ - 1 $ (9,750) $ (9,750) $ (9,750) $ (9,750) $ (9,750) $ 195,000 $ - $ - $ - $ - $ (5,250) $ 163,500 $ (41,250) $ (41,250) $ (41,250) $ (41,250) $ (15,000) 1.000 0.957 0.916 0.876 0.839 0.802 $ 163,500 $ (39,474) $ (37,774) $ (36,147) $ (34,591) $ (12,037) Net advantage of Leasing (NAL) $ 3,477.80 After-tax cost of debt 4.50% -6%*(1-25%)

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