Question

Witten Entertainment is considering buying a machine that costs $549,000. The machine will be depreciated over five years by the straight-line method and will be worthless at that time. The company can lease the machine with year-end payments of $144,000. The company can issue bonds at an interest rate of 6 percent. The corporate tax rate is 24 percent.

What is the NAL of the lease? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

With the buying option :

cash outflow in year 0 = machine cost

cash inflow in years 1 to 5 = depreciation tax shield = annual depreciation * tax rate

annual depreciation = (machine cost / useful life) = $549,000 / 5 = $109,800

depreciation tax shield = $109,800 * 24% = $26,352

With the leasing option :

cash outflow in years 1 to 5 = annual lease expense * (1 - tax rate) = $144,000 * (1 - 0.24) = $109,440

Advantage each year = cash outflow with leasing option - cash outflow with buying option

The present value of each year's advantage is calculated using the discount factor

Discount rate to use = cost of bonds * (1 - tax rate) * 6% * (1 - 0.24) = 4.56%

The sum of the NAL for each year is the NAL of the lease

NAL is -$46,128.33