Question

A manufacturer offers a $50,000 computer hardware equipment with a useful life of 6 years under either a financial lease requiring annual lease payments of $13,000 or under an operating lease with annual lease payments of $16,000. The CCA rate is 25% on the declining balance, the tax rate is 40% and the interest rate on a 6-year term loan is 15%.

How long at a minimum must the useful life of the equipment be in order for the financial lease to be as attractive as the operating lease?

Answer 1

NPV of Cash Outflow if Operating Lease is obtained:

Given that Annual Lease payments ==> $16,000

Tax Savings ==> Lease Payments * 40%

==> $16,000*40%

==> $6,400

Therefore, Net Cash flow ==> $16,000 - $6400 ==> $9,600

Now lets note Present Value Factor

Rate per period ==> 15% & Number of preiods = n

For n=1 then PVF ==> 0.8696

Then PV of net cash outflow ==> $8,348

For n=2 then PVF ==> 0.7561

Then PV of net cash outflow ==> $7,259

For n=3 then PVF ==> 0.6575

Then PV of net cash outflow ==> $6,312

For n=4 then PVF ==> 0.5718

Then PV of net cash outflow ==> $5,489

For n=5 then PVF ==> 0.4972

Then PV of net cash outflow ==> $4,773

For n=6 then PVF ==> 0.4323

Then PV of net cash outflow ==> $4,150

Therefore, Total PV of Net Cash Outflow ==> $36,331

NPV of Cash Outflow if Finance Lease is obtained:

Year	Lease Payments	Capital Cost Allowance	Tax Savings on Capital Cost Allowance	Net Cash Outflow	PVF (15%)	PV of Net Cash Outflow	Cumulative PV
1	$13,000	$12,500	$5,000	$8,000	0.8696	$6,957	$6,957
2	$13,000	$9,375	$3,750	$9,250	0.7561	$6,994	$13,951
3	$13,000	$7,031	$2,813	$10,188	0.6575	$6,698	$20,649
4	$13,000	$5,273	$2,109	$10,891	0.5718	$6,227	$26,876
5	$13,000	$3,955	$1,582	$11,418	0.4972	$5,677	$32,553
6	$13,000	$2,966	$1,187	$11,813	0.4323	$5,107	$37,660

Therefore, Total PV of Net Cash Outflow from above table is

==> $37,660

Lets calculate the Number of Years Equipment's useful life should be

==> 5 + (1/($37,660 - $32,553)) *($36,331 - $32,553))

==> 5 + (1/($5,107) *($3,778))

==> 5 + 0.7397

==> 5.74 Years Long

Please Encourage us by Up Voting the Answer which is Very Helpful to us. Thank You!