Question

Imagine yourself in the position of Thomas Pierce III, president of Greymare Bus Lines. Your firm was established by your grandfather, who was quick to capitalize on the growing demand for transportation between Widdicombe and nearby townships. The company has owned all its vehicles from the time the company was formed; you are now reconsidering that policy. Your operating manager wants to buy a new bus costing $85,000. The bus will last only eight years before going to the scrap yard. You are convinced that investment in the additional equipment is worthwhile. However, the representative of the bus manufacturer has pointed out that her firm would also be willing to lease the bus to you for eight annual payments of $15,400 each. Greymare would remain responsible for all maintenance, insurance, and operating expenses. If Greymare does not own the bus it cannot depreciate it and therefore, it gives up a valuable depreciation tax shield. We assume depreciation would be calculated immediately. Greymare’s borrowing rate is 10%. Assume this is a financial lease.

a. What is the value of the lease if Greymare’s marginal tax rate is T_c = 0.30? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer in thousands rounded to 2 decimal places.)

	Value of the lease thousands

b. What would the lease value be if the tax rate is 21%, but for tax purposes, the initial investment had to be written off in equal amounts over years 1 through 5? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer in thousands rounded to 2 decimal places.)

	Value of the lease thousands

Answer 1

a. Net Value of the lease = $1,989.50 or $1.99 thousands

b. Net Value of the lease = $6,562.18 or $6.56 thousands

The net value of the lease is positive in both the scenarios. Hence, the firm can lease the bus instead of purchasing it.