Question

i hope i can have clearly explanation about how to find the answers.

15. Setting the Lease Price An asset costs $620,000 and will be depreciated in a straight-line manner over its three-year life. It will have no salvage value. The lessor can borrow at 7 percent and the lessee can borrow at 9 percent. The corporate tax rate is 34 percent for both companies. a. How does the fact that the lessor and lessee have different borrowing rates affect the calculation of the NAL? b. What set of lease payments will make the lesseo and the lessor equally well oft? c. Assume that the lessee pays no taxes and the lessor is in the 34 percent tax bracket. For what range of lease payments does the lease have a positive NPV for both parties? ation.asia oidross

Answer 1

A)Actually different borrowing rates here in this case doesn't matter. The person who borrows should need to look after the return on captial employed and risk associated along with the project.

B)Both companies have the same tax rate, there is only one lease payment.i.e., from Lesse and that will result in a zero NAL for each company. Calculation of cash flows from the depreciation tax shield :

Depreciation tax shield = ($620,000/3)(.34) = $70,266.67.

Lessee's cost of debt is aftertax cost of debt - Aftertax debt cost = .09(1 – .34) = .0594.

Lets now calculate lease payment - NAL = 0 = $620,000 – PMT(1 – .34)(PVIFA5.94%,3) - $70,266.67(PVIFA5.94%,3)PMT = $244,581.78.

C)The lessor’s tax bracket is unchanged, we know this from Part B answer. The lessee will not get depreciation tax shield, and the aftertax cost of debt will be the same as the pretax cost of debt. Now lets determine the lessee’s maximum lease payment :

NAL = 0 = –$620,000 + PMT(PVIFA9%,3) PMT = $244,933.95.

Both parties have positive NAL for lease payments between $244,581.78 & $244,933.95.18.