A lease has five annual payments of $115,000. The leased asset would cost $500,000 to buy,...

A lease has five annual payments of $115,000. The leased asset would cost $500,000 to buy, would be depreciated straightline to a zero salvage value over 5 years, and has an actual salvage value of zero. The firm can borrow at 8 percent on a pretax basis and has a tax rate of 23 percent. What is the net advantage of leasing?

Expert Solution

Net advantage of leasing is $ 32,149.05

Step-1:Calculation of annual cash flows under lease option

After tax lease payment	115000*(1-0.23)		=	$ 88,550.00
Lost depreciation tax shield	100000*0.23		=	$ 23,000.00

Total annual cash flow				$ 1,11,550.00

Working:

Straight line depreciation	=	(Cost - Salvage Value)/Useful Life
	=	(500000-0)/5
	=	$ 1,00,000.00

Step-2:Calculation of net advantage of leasing

Buy price of asset						$ 5,00,000.00
Present value of leasing cash flow		$ 1,11,550.00	*	4.194091931	=	$ 4,67,850.95

Net Advantage of leasing						$ 32,149.05

Working:

After tax discount rate	=	8%*(1-0.23)	=	0.0616

Present value of annuity of 1	=	(1-(1+i)^-n)/i		Where,
	=	(1-(1+0.0616)^-5)/0.0616		i	=	0.0616
	=	4.194091931		n	=	5

jeff jeffy answered 4 months ago

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