Question

Wheat Chex leases a thresher from John Deere. The cost of the thresher is $2,000,000. The lease will last for two years. The company uses straight line depreciation over five years to depreciate the equipment. The estimated salvage value is $1,500,000. The corporate tax ratefc both firms is 40%. The cost of borrowing is 10% and the required rate of return is 15%. 

Assume you are John Deere: 

Round to the nearest dollar. 

What is the after-tax salvage value? 

What is the present value of the after-tax salvage value? 

If the present value of the other non-SV cashflows is $1,000,000, what is the NAL of the lease?

Answer 1

Salvage Value is $1,500,000
Tax rate = 40%

After tax salvage value = Salvage Value - Tax rate
After tax salvage value = (1,500,000 - 40% of 1,500,000) = $900,000

Present Value of After tax salvage value = After tax salvage value * PVIF(15%, 5)
Present Value of After tax salvage value = 900,000 * 0.4972   = $447,480

To calculate the net advantage of leasing, we need details regarding borrowings i.e. we need to evaluate the costs that would be incurred when the borrowing option is taken. We will compare the same with the costs incurred in the leasing option and then we can calculate net advantage of leasing. Here, we are not given the details of the borrowing option i.e. number of years of the loan etc. therefore, NAL cannot be calculated.