Question

Walther Corporation is deciding between purchasing needed equipment or leasing it. If purchased, it has calculated its total expected after-tax cash outflows each year as follows: Year 1 $250,000; Year 2 $225,000; Year 3 $200,000; Year 4 $150,000; and Year 5 $100,000 with annual cash flows assumed to be generated evenly throughout the year (use the mid-year adjustment). If leased, the annual after-tax lease payment of $187,500 would be due at the beginning of each of the next five years. The company’s cost of debt is 5%. What is the net advantage to leasing (NAL)? If leasing is more expensive, be certain to place a negative sign before your answer. show work in excel!

Answer 1

Walther Corporation

In Mid Year Convention we shall use the disount

factor =1/(1+r)^(n-0.5) where, r= discount/interest rate

and n = no of period

Given : Discount rate =5% = cost of Debt

Let us find the PV of Purchase :

Year=n	After Tax cash flow	PV factor Using Mid Year convention =1/(1+r)^(n-0.5) , where r=5%	PV of After Tax Cash flow
1	250,000	0.9759	243,975
2	225,000	0.9294	209,115
3	200,000	0.8852	177,040
4	150,000	0.8430	126,450
5	100,000	0.8029	80,290
Total			836,870

Noe let us find the PV of Leasing cost
Here cash flow occuring at the beginning of the year , so dicounting factor will be =1/(1+r)^(n-1)
where r=discount rate and n=no of period . For example for Year 2 cash receipt, the period of discount will
be one year , not 2 years as cash is received at the start of year 2 or at th end of year 1.

Year=n	After Tax cash flow	PV factor =1/(1+r)^(n-1) , where r=5%,	PV of After Tax Cash flow
1	250,000	1.0000	250,000
2	225,000	0.9524	214,290
3	200,000	0.9070	181,400
4	150,000	0.8638	129,570
5	100,000	0.8227	82,270
Total			857,530

So PV of Leasing cost =$857,530
Net Advantage of Leasing =$836,870-$857,530=	$       (20,660.00)