Question

Carnival Company is considering leasing a new equipment. The lease lasts for 8 years. The lease calls for 10 payments of $9,000 per year with the first payment occurring immediately. The equipment would cost $60,000 to buy and would be straight-line depreciated to a zero salvage value over 8 years. The actual pre-tax salvage value is $4,000. The firm can borrow at a rate of 6%. The corporate tax rate is 25%. What would the NPV of the lease relative to the purchase be?

Answer 1

Answer: IRR will be Interest(1-tax rate) = 6(1-0.25) = 4.5%

(i) Cash Outflow in lease option :-

(1) End of year	(2) Lease Payment	(3) Tax shield	(4) Cash Inflow	(5) PVIFA @ 4.5%	(6) PV = (4)*(5)
0	9000	0	9000	1	9000
1	9000	2250	6750	0.957	6459.75
2	9000	2250	6750	0.916	6183
3	9000	2250	6750	0.876	5913
4	9000	2250	6750	0.839	5663.25
5	9000	2250	6750	0.802	5413.5
6	9000	2250	6750	0.768	5184
7	9000	2250	6750	0.735	4961.25
8	9000	2250	6750	0.703	4745.25
9	9000	2250	6750	0.673	4542.75
10	0	2250	-2250	0.644	-1449
Total					56616.75

Cash Inflow in leasing option will be 56616.75$

(ii) Cash outflow in buying option:-

The firm will borrow 60000$ for 8 years @ 6% ,

Let 60000$ will be pay in equal amount along with interest , therefore equal principal will be 60000$ /8 = 7500$ p.a. , Payment will be starting from begining of the year & Depriciation will be 60000$ - 4000$ =56000$/8 = 7000$ p.a.

(1) End of the year	(2) Principal	(3) Interest	(4) Depriciation	(5) Tax sheild{3+4}*25%	(6) Cash outflow (2+3)-5	(7) [email protected]%	(8) PV
1	7500	3600	7000	2650	8450	0.957	8086.65
2	7500	3150	7000	2537.5	8112.5	0.916	7431.05
3	7500	2700	7000	2425	7775	0.876	6810.9
4	7500	2250	7000	2312.5	7437.5	0.839	6240.06
5	7500	1800	7000	2200	7100	0.802	5694.2
6	7500	1350	7000	2087.5	6762.5	0.768	5193.6
7	7500	900	7000	1975	6425	0.735	4722.37
8	7500	450	7000	1862.5	6087.5	0.703	4279.513
total							48458.35

Hence , NPV of cash outflow will be 48458.35$

Profit will be 56616.75 $ -48458.35$ = 8158.4 $ on leasing equipment