Question

Healthsouth Company is considering leasing a new equipment. The lease lasts for 8 years. The lease calls for 8 payments of $111,000 per year with the first payment occurring immediately. The equipment would cost $724,000 to buy and would be straight-line depreciated to a zero salvage value over 8 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 6.5%. The corporate tax rate is 25%. The actual pre-tax salvage value is $15,000. What would the NPV of the lease relative to the purchase be?

		-$3,427.15
		$2,185.31
		$4,263.89
		$6,349.75
		-$1,056.33

Answer 1

Solution :

The NPV of the lease relative to the purchase = $ 2,185.31

The solution is Option 2 = $ 2,185.31

Note :

The discount rate used in the solution is the after tax discount rate.

As per the information given in the question we have

Discount rate = 6.5 % ; Tax rate = 25 % = 0.25

Thus, after tax discount rate = Discount rate * ( 1 - Tax rate )

= 6.5 % * ( 1 - 0.25 ) = 6.5 % * 0.75 = 4.875 %

Please find the attached screenshots of the excel sheet containing the detailed calculation for the above solution.