In: Finance
You work as a financial analyst at WPWilly, Inc. You are evaluating how much Acme Limo should charge a client who will lease a car for 7 years. It will cost Acme $85,000 to buy the car and the car can be depreciated on a five-year MACRS schedule. Acme Limo’s pretax administrative costs including Maintenance, Insurance and Selling Cost are $10,000 per year and they occur at the beginning of each year. The after tax cost of capital is 10% and the tax rate is 21%. Lease payments are made in advance, that is, at the start of each year. The inflation rate is zero.
a. How much is the present value of after tax administrative
costs? (sample answer:$2500.50)
b. What is the present value of Depreciation tax
Shield? (sample answer:$2500.50)
c. What is the after tax break-even operating lease rate for the
car? (sample answer: $2500.50)
d. What is the before tax break even operating lease rate for the
car? (sample answer: $2500.50)
Depreciation Table for 5-year asset
Year %
1 20.00%
2 32.00%
3 19.20%
4 11.52%
5 11.52%
6 5.76%
I have answered the question below
Please up vote for the same and thanks!!!
Do reach out in the comments for any queries
Answer:
1)
Administrative costs per year incurred at the beginning of each year = $10,000
After tax cost of capital is = 10% and
Tax rate is = 21%
After tax administrative costs per year = 10000 * (1 - 21%) = $7,900
Present value of after tax administrative costs = PV(rate, nper, pmt, fv, type) = PV(10%, 7, -7900, 0, 1)
=$42306.56
2)
Present value of Depreciation tax Shield = $13,802.70
Working:
3)
Present value of cost of limo, administrative cost net of tax and present value of depreciation tax shield =
= 85000 + 42,306.56 - 13802.70
= $113,503.86
PV of $1 annuity due for 7 years at 10% = ((1 - 1/(1+10%)^7)/10%) * (1 + 10%) = 5.355260699
After tax break-even operating lease rate for the car = 113503.86 / 5.355260699 = $21,194.83
4)
Before tax break even operating lease rate for the car = After tax break-even operating lease rate for the car / (1 - Tax rate)
= 21194.83 / (1 - 21%)
= $26,828.90