In: Finance
Lease vs Buy
Purchase 10 million
Depreciate 5 years straight line to zero
Expected salvage 2 million
Tax rate 40%
Lease payments 2 million at beginning of year
Cost of equity 10%
Cost of debt 5%
D/E = 1
Cost of capital?
Cost of ownership?
Value of dep tax shield
Value of ownership?
Value of lease?
Cost of capital
Cost of capital = Cost of equity * Weight + After tax cost of debt * Weight
= 10% * 0.5 + 5%(1-0.4) * 0.5
= 6.5%
Cost of ownership
Cost of ownership = Purchase cost- Tax savings on depreciation - Salvage value
= $10 million - (40%*$2 million*5 years) - $2 million
= $4 million
Value of dep tax shield
Year | 1 | 2 | 3 | 4 | 5 | Total |
Depreciation | $ 2 | $ 2 | $ 2 | $ 2 | $ 2 | $ 10.00 |
Tax savings @ 40% | $ 0.80 | $ 0.80 | $ 0.80 | $ 0.80 | $ 0.80 | $ 4.00 |
PVF @ 6.5% | 0.94 | 0.88 | 0.83 | 0.78 | 0.73 | |
Value of dep. tax shield | $ 0.75 | $ 0.71 | $ 0.66 | $ 0.62 | $ 0.58 | $ 3.32 |
Value of ownership
Year | 0 | 1 | 2 | 3 | 4 | 5 | Total |
Purchase cost | (10.00) | $ (10.00) | |||||
Tax savings @ 40% | - | 0.80 | 0.80 | 0.80 | 0.80 | 0.80 | $ 4.00 |
Salvage value | - | - | - | - | - | 2.00 | $ 2.00 |
Cost of ownership | (10.00) | 0.80 | 0.80 | 0.80 | 0.80 | 2.80 | $ (4.00) |
PVF @ 6.5% | 1 | 0.94 | 0.88 | 0.83 | 0.78 | 0.73 | |
Value of ownership | (10.00) | 0.75 | 0.71 | 0.66 | 0.62 | 2.04 | $ (5.22) |
Value of lease
Year | 0 | 1 | 2 | 3 | 4 | Total |
Lease payments | 2.00 | 2.00 | 2.00 | 2.00 | 2.00 | $ 10.00 |
PVF @ 6.5% | 1 | 0.94 | 0.88 | 0.83 | 0.78 | |
Value of lease | 2.00 | 1.88 | 1.76 | 1.66 | 1.55 | $ 8.85 |