Question

Your firm is considering leasing a new computer. The lease lasts for 8 years. The lease calls for 8 payments of $8,000 per year with the first payment occurring immediately. The computer would cost $50,000 to buy and would be straight-line depreciated to a zero over 8 years. The actual pre-tax salvage value is $3,000. The firm can borrow at a rate of 5%. The corporate tax rate is 34%. What would the NPV of the lease relative to the purchase be?

-$2,780.42

-$4,064.08

-$3,927.15

$2,318.71

$3,061.26

Answer 1

The lease has to be considered operational lease so you cant depreciate the same. Hence no tax shield.

Case 1

Buying Asset. You will receive tax sheilds for depreciation

50000/8=6250 and tax shield will be 6250*0.34=2125 and pv of tax shields which can be considered as inflows be as follows.In the terminal year company gets proceeds from the sale of asset=1980(after taxes;capital tax ,not eligible for tax sheilds) so the summation of PV will be 15,074 and NPV will be -34,925.

Option 2 lease

Only lease amount be subject to tax savings and no salvage value. first payment shouldn't be present valued because its paid out as soon as term starts. So taking PV of all the outflows after the tax benefit assuming lease payments provide tax shiled will be as follows .Summing up to 35,832

5280

5028.571

4789.116

4561.063

4343.869

4137.018

3940.017

3752.397

Hence the loss on applying for lease be (906.52).None of the above