Question

Your firm is considering leasing a new computer. The lease lasts for 4 years. The lease calls for 5 payments of $450 per year with the first payment occurring immediately. The computer would cost $5,900 to buy and would be depreciated using the straight-line method to zero salvage over 4 years. The firm can borrow at a rate of 5%. The corporate tax rate is 20%. What is the NPV of the lease?

Answer 1

NPV or the net present value from leasing also called as the Net Advantage of Leasing is the benefits received by the company in present value terms by leasing an asset instead of buying it.

Discount rate = Borrowing rate x (100 - Tax)
= 5% x 80%
= 4%

Now,

The after-tax cash flow of Year 0, Years 1-4 and NPV of leasing is:

Years	Cost of Asset	Lease Payments	After tax lease payments (Lease payment x (100 - Tax Rate)	Lost depreciation tax shield (Depn x Tax Rate)	Total cash flow (After tax lease payment + Lost depn tax shield)	Discounting Factor = (1/1+rate)^number of years	Present value
0	5,900	-450	-360		5,540	1	5540
1	-	-450	-360	-295	-655	0.96	-681.2
2	-	-450	-360	-295	-655	0.92	-708.45
3	-	-450	-360	-295	-655	0.89	-736.79
4	-	-450	-360	-295	-655	0.85	-766.26
Sum							2647.31

Depreciation = Cost / Life = $5,900 / 4 = $1,475

Since the asset will not be purchased if it is leased, it is a benefit for the company.

Lease payments qualify as an expense so tax benefit will arise, hence after-tax lease payments are considered.

The company would not be able to claim depreciation, and so lost depreciation tax shield is an outflow.

Cash flow of Year 0 = $5,540

Cash flow from Years 1-9 = -$655

NPV of leasing = $2,647.31

As the NPV of the lease is positive, the firm would benefit from leasing the computer rather than buying it.