Question

Your firm is considering leasing a magic box. The lease lasts for three years. The lease calls for three payments of $1,350 per year with the first payment occurring at lease inception. The magic box would cost $3,600 to buy and would be straight-line depreciated to zero salvage value over three years. The firm can borrow at 6 percent, and the marginal corporate tax rate is 21 percent. What is the NPV of the lease?

Select one:

a. $30.50

b. −$30.50

c. −$65.75

d. −$146.51

e. None of the above

Answer 1

Cash flows for the period:-

	Year 0	Year 1	Year 2
Purchase of magic Box	-3600
Lease Payments (Since payments made at beginning of year)	+1350	+1350	+1350

Free cash flows profit for the period

Particulars	Year 0	Year 1	Year 2	Year 3
Lease Rentals	+1350	+1350	+1350
Less: Depreciation		-1200	-1200	-1200
Profit before tax	+1350	+150	+150	-1200
Less: Tax @21%	-283.5	-31.5	-31.5	+252
Profit after Tax	1066.5	+118.5	+118.5	-948
Add: Depreciation (Non Cash Adjustments)		+1200	+1200	+1200
Free Cash Flows	1066.5	1318.5	1318.5	252

Discounted Free Cash Flow

Year	Free Cash Flows	PVF @6%	Discounted Values
0	1066.5	1	1066.5
1	1318.5	0.94	1239.4
2	1318.5	0.89	1173.5
3	252	0.84	211.7
			3691.1

NPV of the Lease = Discounted Inflows - Outflow in 0 period

= 3691.1 - 3600

= +91.1

e) None of the Above

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