Question

Your firm is considering leasing a radiographic x-ray machine. The lease lasts for 3 years. The lease calls for 4 payments of $25,000 per year with the first payment occurring immediately. The computer would cost $140,000 to buy and would be straight-line depreciated to a zero salvage value over 3 years. The actual salvage value is negligible. The firm can borrow by issuing debt at a rate of 12%. The corporate tax rate is 40%. What is the NPV of the lease relative to the purchase?

A. -$125,000

B. $115,412

C. $75,000

D. $125,000

E. None of these For accounting purposes,

2-which of the following conditions would automatically cause a lease to be a capital lease?

A. The lessee can purchase the asset below fair market value at the end of the lease.

B. The lease transfers ownership of the asset to the lessee by the end of the lease.

C. The lease term is more than 75% of the asset's economic life.

D. The present value of the lease payments is more than 90% of the asset's market value at lease inception.

E. All of these would lead to the lease being considered a capital lease.

Answer 1

Correct answers:

1. E. None of these

2. E. All of these would lead to the lease being considered a capital lease.

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

в с Cost of borrowing Tax rate After tax cost of borrowing 12.00% 40.00% 7.20% Lease Annual Payments After tax Annual Cash Flow No. of payments NPV of Lease $25,000.00 $15,000.00 $54,221.34 $140,000.00 Buy Purchase cost useful life in years Annual depeciation Tax shield of depreciation PV of Tax shield NPV of Buy $46,666.67 $18,666.67 $48,808.78 $91,191.22 17 NAL $36,969.88

Cell reference -

B 0.12 Cost of borrowing Tax rate After tax cost of borrowing 0.4 =C2*(1-C3) Lease Annual Payments After tax Annual Cash Flow No. of payments NPV of Lease 25000 =C7*(1-C3) =PV(C4,C9,-C8,,1) 140000 Buy Purchase cost useful life in years Annual depeciation Tax shield of depreciation PV of Tax shield NPV of Buy =C13/C14 =C15*C3 =PV(C4,C14,-C16,,0) =C13-C17 NAL =C18-C10

Hope it will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.