Question

Green Valley Farms is considering either leasing or buying some new farm equipment. The lessor will charge $23,000 a year lease. The purchase price is $63,000. The equipment has a 3-year life after which time it will be worthless. Green Valley Farms uses straight-line depreciation, has a 32 percent tax rate, borrows money at 9 percent, and has sufficient tax loss carryovers to offset any potential taxable income the firm might have over the next five years. What is the net advantage to leasing?

Answer 1

Tax benefit can be taken for lease payment and depreciation. As tax loss carryovers are available
Cost of buying =	63000
Annual lease payment=	23000
After tax lease payment = 23000*(1-32%)=	15640
Borrowing rate is cost of capital that is 9% or 0.09. After tax rate (i) = 0.09*(1-32%)	0.0612
Time (n)=	3
Present value of Lease payment=	Annual lease cost * (1- (1/(1+r)^n))/r
15640*(1-(1/((1+0.0612)^3)))/0.0612
41713.26256
Depreciation tax benefit per year = Cost of asset/3 * tax rate
63000/3*32%=	6720
Present value of tax benefit of depreciation =
6720*(1-(1/((1+0.0612)^3)))/0.0612
17922.83404
Total cost of buying = cost of machine - tax benefit of depreciation
63000-17922.83=	45077.16596
Net advantage to leasing = Present value of Savings in buying Cost - Present value of Lease payments
45077.16596 -41713.26256
3363.903403
So Net advantage to Lease is $3363.90