Question

Airmax is considering leasing a new equipment. The lease lasts for 5 years. The lease calls for 5 payments of $11,300 per year with the first payment occurring immediately. The equipment would cost $44,000 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 after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in year 0?

		$35,525
		$44,000
		$11,300
		$32,700
		$27,500

Answer 1

Solution :

The after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in year 0 is = $ 35,525

Thus the solution is Option 1

The discount rate used in the solution is the after tax discount rate.

As per the information given in the question we have

Discount rate = 6 % ; Tax rate = 25 % = 0.25

Thus, after tax discount rate = Discount rate * ( 1 - Tax rate )

= 6 % * ( 1- 0.25 ) = 6 % * 0.75 = 4.5 %

Please find the attached screenshot of the excel sheet containing the detailed calculation for the above solution.

5.04.2019 - Excel FILE HOME INSERT PAGE LAYOUT FORMULAS DATA REVIEW VIEW Statement showing calculation of after tax cash flow from the Lease Option in Year 0 After Tax Lease Tax @25 % (2)-(1) * 025 SI.No. Particulars Amount | PVF @ 4.5 % | Discounted Cash Lease t Year 0 $ -11,300.00 $ 2,825.00 S 8,475.00 1.0000 8,475.00 8,475.00 After tax cash flow from the Lease o in Year Statement showing calculation of after tax cash flow from the Purchase Option in Year 0 Sl.No. Particulars Depreciation $44000/5-8800 3)-(2)0.25 Amount Tax shield @ 25 % Total of cash | PVF @ 4.5 % Discounted Cash Flows 1 Cash Outflow Initial Investment- Year 0 S -44,000.00 $ -44,000.00 44,000.00 After tax cash flow from the Purchase option in Year 0 -44,000.00 10 Statement showing after-tax cash flow from leasing relative to the after-tax cash flow from r 0 SI.No. Particulars Amount 1 After tax cash flow from the Lease option in Year 0 2 Less: After tax cash flow from the Purchase option in Year0-44,000.00 3 After-tax cash flow from leasing relative to the after-tax cash 35,525.00 $-8,475.00 15 flow from purchasing in year 0 16 18