Question
In: Finance
AHS must install a new $1.5 million computer to track patient records in its multiple service...
AHS must install a new $1.5 million computer to track patient records in its multiple service areas. It plans to use the computer for only 3 years, at that time a new system will be acquired that will handle both billing and patient records. The company can borrow money at a before-tax cost of 10%. In lieu of buying, AHS could lease the computer for 3 years.
Assume that the following facts apply:
The computer falls into the 3-year class for tax depreciation, so the modified accelerated cost recovery system (MACRS) allowances are 0.33, 0.45, 0.15, and 0.07 in Year 1 through Year 4, respectively.
The company's marginal tax rate is 34%.
Tentative lease terms call for payments of $500,000 at the beginning of each year.
The best estimate for the value of the computer after 4 years of wear and tear is $300,000.
What is the internal rate of return (IRR) of the lease?
Solutions
Expert Solution
Answer :
IRR of Leas option is required.
We calculate below:
1. Cash flows for option 'Buy'. The machine is used for 3 years; after which it is 'held for sale' and sold at the end of year 4.
2. Cash flows for option 'Lease'. Since annual lease payments have to be made at the beginning of the year, cash flows for the same is taken as at the end previous year.
3. Incremental cash flow of (2) over (1) and IRR.
IRR of the lease option is 4.21% as calculated below:
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