Question

Rearden Metal is considering the purchase of a new blast furnace costing a total of $5 million dollars. This furnace will qualify for MACRS 5-year depreciation (20%, 32%, 19.20%, 11.52%, 11/52%, 5.76%) . However, because of Rearden's substantial tax loss carry forwards, Rearden estimates its marginal tax rate to be only 10% over the next five years. Since Rearden will get very little tax benefit from the depreciation expense, they consider leasing the furnace instead. Suppose that Rearden and the lessor face the same 8% borrowing rate, but the lessor has a 40% marginal tax rate. Assume that the furnace is worthless after five years, the lease term is five years, and a lease would qualify as a true tax lease.

Assuming that Rearden's annual lease payments are $1.2 million, payable at the beginning of the year, what is the net advantage of leasing?

Answer 1

Based on the given data, pls find below workings on the NPV of the total net cash outflows for both the alternatives:

All nos in $; Based on the below, the NPV of net cash out flows for Purchase option is $ 4594337.10 and that of Leasing is $ 4657096.99; Given this, there is no net advantage in leasing option; Infact if they go with leasing option, there is an additional PV of Net cash out flow of 62759.88