Question

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?

Answer 1

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