Question

You work for a nuclear research laboratory that is contemplating leasing a diagnostic scanner (leasing is very common practice with expensive, high-tech equipment). The scanner costs $6.7 million and it qualifies for a 30% CCA rate. Because of radiation contamination, it is valueless in four years. You can lease it for $1.895 million per year for four years. You can borrow at 8.0% pre-tax. Assume that the assets pool remains open and payments are made at the end of the year.

Assume that your company does not contemplate paying taxes for the next several years. Calculate the NAL.

NAL      $ ____

Answer 1

There are no taxes. Therefore :

• the depreciation tax shield does not need to be considered
• The pre-tax rate of borrowing is used as the discount rate
• Pre-tax lease payments equal the after-tax lease payments

Net advantage of leasing is the NPV of the lease relative to the purchase.

This is calculated by calculating the present value of the advantage each year.

Advantage each year = Cash flow with leasing - cash flow with buying.

Buying :

Cash outflow in year 0 = cost of equipment.

Leasing :

Net cash outflow with leasing = lease payment

NPV of leasing vs buying

Advantage each year = Cash flow with leasing - cash flow with buying.

Present value factor (discount factor) each year = 1 / (1 + discount rate)^year.

Discount rate = cost of borrowing = 8%.

Net Advantage of leasing each year = advantage amount * discount factor.

NPV of the lease relative to the purchase = $423,519.64

NAL = $423,519.64