Question

Hatwick Technology is considering leasing a new equipment. The lease lasts for 5 years. The lease calls for 5 payments of $10,200 per year with the first payment occurring immediately. The equipment would cost $44,000 to buy and would be straight-line depreciated to a zero salvage value over 5 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 6%. The corporate tax rate is 34%. What is the NPV of the lease relative to the purchase if the asset had a residual value of $800 (ignoring any possible risk differences)?

		$805.73
		-$1,137.80
		-$1,411.48
		-$961.15
		$1,218.34

Answer 1

Calculation NPV of lease option
Year	Lease payments (after tax)	Discount Factor @ 6%	Present Values
0	-$6,732.00	1	-$6,732.00
1	-$6,732.00	0.943396	-$6,350.94
2	-$6,732.00	0.889996	-$5,991.46
3	-$6,732.00	0.839619	-$5,652.32
4	-$6,732.00	0.792094	-$5,332.37
5	$0.00	0.747258	$0.00
NPV of Lease option			-$30,059.09
Calculation of NPV of purchase option
Year	0	1	2	3	4	5	NPV of Purchase option
Cost of equipment	-$44,000.00
Tax savings due to depreciation		$2,992.00	$2,992.00	$2,992.00	$2,992.00	$2,992.00
After tax residual value						$528.00
Net Cash Flow	-$44,000.00	$2,992.00	$2,992.00	$2,992.00	$2,992.00	$3,520.00
Discount Factor @ 6%	1	0.9434	0.8900	0.8396	0.7921	0.7473
Present Values	-$44,000.00	$2,822.64	$2,662.87	$2,512.14	$2,369.94	$2,630.35	-$31,002.06
the NPV of the lease relative to the purchase if the asset had a residual value of $800 = - $942.96 [-$31002.06 + $30059.09]
Hence the answer is -$961.15
Working
Depreciation per year using straight line method = $44000/ 5 years = $8800
Tax savings due to depreciation = $8800 * 34% = $2992