Witten Entertainment is considering buying a machine that costs $560,000. The machine will be depreciated over...
Witten Entertainment is considering buying a machine that costs $560,000. The machine will be depreciated over four years by the straight-line method and will be worthless at that time. The company can lease the machine with year-end payments of $173,000. The company can issue bonds at an interest rate of 7 percent. The corporate tax rate is 25 percent.
What is the NAL of the lease?
Homework Answers
NAL $ -20,818.66. So, there is no advantage of leasing.
| Step-1:Calculation of Present value of cash flow under leasing option | |||||
| Year | After Tax Lease Rental | Lost depreciation tax shield | Total Cash Flow | Discount factor | Present Value |
| a | b | c | d=b+c | e=1.0525^-a | f=d*e |
| 1 | 1,29,750.00 | 35,000.00 | 1,64,750.00 | 0.9501 | 1,56,532.07 |
| 2 | 1,29,750.00 | 35,000.00 | 1,64,750.00 | 0.9027 | 1,48,724.05 |
| 3 | 1,29,750.00 | 35,000.00 | 1,64,750.00 | 0.8577 | 1,41,305.51 |
| 4 | 1,29,750.00 | 35,000.00 | 1,64,750.00 | 0.8149 | 1,34,257.02 |
| Total | 5,80,818.66 | ||||
| Working: | |||||
| After Tax lease rental | = | Lease rental * (1-Tax Rate) | |||
| = | 173000*(1-0.25) | ||||
| = | 1,29,750 | ||||
| Straight Line depreciation | = | (Cost - Salvage Value)/Useful life | |||
| = | (560000-0)/4 | ||||
| = | 1,40,000 | ||||
| Depreciation Tax Shield | = | Depreciation Amount* Tax Rate | |||
| = | 140000*25% | ||||
| = | 35000 | ||||
| After -Tax Discount rate | = | Interest rate*(1- Tax Rate) | |||
| = | 7%*(1-0.25) | ||||
| = | 0.0525 | ||||
| Step-2:Calculation of net advantage of leasing | |||||
| Cost of asset | 5,60,000.00 | ||||
| Less Present value of cash flow under lease option | 5,80,818.66 | ||||
| Net Advantage of Leasing | -20,818.66 |
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