Question

The lessor for Dolby Corp is AAA Rental. The following information applies to AAA Rental:

The purchase cost is $350,000. The equipment will be depreciated as MACRS 3-Year Property (DepYR1 = 33.33%; DepYr2 = 44.45%). A two-year maintenance contract will cost $15,000 at the start of each of the two years of ownership.

AAA Rental estimates a residual equipment value after two years of use of $200,000 (before taxes).

Beginning-of-year rental income will be two lease payments of $150,000 each.

AAA Rental faces a 50% marginal tax rate and a 7% interest rate on debt.

What are AAA Rental’s cash flows associated with the leasing project? What is the NPV of the rental project?

Answer 1

1 G All cash flows which are made as on begining date of the year as considered as made on last date of previous year Year Rental Income Sale of equipment Total Cash Inflows Begining of the year End of the year $ 1,50,000.00 $1,50,000.00 $2,00,000.00 $1,50,000.00 $2,00,000.00 $ 1,50,000.00 Purchase Value Maintenance Cost Tax Total Cash Outflows At Year o Begining of the year End of the year $ 3,50,000.00 $ 15,000.00 $ 15,000.00 $ 9,172,50 $ 3,65,000.00 $ 24,172,50 S 89,712.50 S 89,712.50 Net Cash Flows $-2,15,000.00 $1,25,82750 $1,10,287.50 un Cash Flows Discounting Factor =(1+7%)“year 1.00 1.07 114 Net Present Value Present Value = Net Cash Flows / Discounting Factor S-2,15,000.00 $1,17,595.79 S 96,329.37 5 -1,074.83 NPV $ 1,50,000.00 $1,50,000.00 $ 2,00,000.00 $ 1,50,000.00 $3,50,000.00 000 NO ON 0 Workings - Calculating Tax Expenses Year Rental Income Sale of equipment Total Income Less : Maintenance Cost Depreciation Year 1 : 33.33% of Cost Year 2:44.45%of Cost Net Income Before Tax Less Tax Net Income After Tax $ 15,000.00 $ 15,000.00 $ 1,16,655.00 $1,55,575.00 $ 18,345.00 $1,79,425.00 50% S S 9,172.50 S 89,712.50 9,172.50 $ 89,712.50