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Quartz Corporation is a relatively new firm. Quartz has experienced enough losses during its early years...

Quartz Corporation is a relatively new firm. Quartz has experienced enough losses during its early years to provide it with at least eight years of tax loss carryforwards. Thus, Quartz’s effective tax rate is zero. Quartz plans to lease equipment from New Leasing Company. The term of the lease is five years. The purchase cost of the equipment is $840,000. New Leasing Company is in the 35 percent tax bracket. There are no transaction costs to the lease. Each firm can borrow at 10 percent.

a. What is Quartz’s reservation price?

b. What is New Leasing Company’s reservation price?

Solutions

Expert Solution

(a.) To calculate the reservation Price , we set Net Advantage of Leasing as 0

Since Given there is zero tax rate therefore, there will be no deprection tax shield and also cost of borrowing before tax and after tax is same.

Net Advantage of Leasing = Purchase Cost - (Per month payment * PVAF @10% for 5 years)

0 = 840000 - (Per Month payment * 3.79078676939)

==> Per month payment is 840000 / 3.79078676939

= 221,589.88

(b.) Calculation of New Leasing Company Reservation Price :

Since Given there is 35% tax rate therefore,

there will be no deprection tax shield = (840,000 / 5 ) * 0.35 = 58800

and also cost of borrowing after tax is = 10% * (1 - 0.35) = 6.5%

Net Advantage of Leasing = Purchase Cost - [Per month payment * PVAF @6.5% for 5 years * (1 - Tax rate)] + [Depreciation Tax shield * PVAF @6.5% for 5 years]

0 = 840000 - [(Per Month payment * (1 - 0.35) * 4.15567943808] + [58800 * 4.15567943808]

==> Per Month Payment = [840000 - 244,353.950959] / 2.70119163475

= 220,512.33

jeff jeffy answered 2 years ago
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