Question

An asset costs $750,000 and will be depreciated in a straight-line manner over its three-year life. It will have no salvage value. The lessor can borrow at 5.8 percent and the lessee can borrow at 8.3 percent. The corporate tax rate is 21 percent for both companies.

a

What would the lease payment have to be to make both the lessor and lessee indifferent about the lease? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

b Assume that the lessee pays no taxes and the lessor pays taxes. For what range of lease payments does the lease have a positive NPV for both parties? (Enter your answers from lowest to highest. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

Answer 1

a)
Depreciation = cost of asset / life
= $750,000 / 3
= $250,000.

Depreciation tax shield = Depreciation * tax rate
= $250,000 * 21%
= $52,500.

After tax borrowing rate = Borrowing rate * (1 - tax rate)
= 8.3% * (1 - 0.21)
= 6.557%

Net advantage of leasing = cost of asset - Operating cash flow * (PVIFA 6.557%,3 years)

0 = $750,000 - Operating cash flow * 2.645702

Operating cash flow = $750,000 / 2.645702

Operating cash flow = $283,478.59

Operating cash flow = After tax lease payment + Depreciation tax shield

$283,478.59 = After tax lease payment + $52,500

After tax lease payment = $283,478.59 - $52,500 = $230,978.59

Before tax lease payment = $230,978.59 / (1 - 0.21) = $292,377.96

Break-even lease payment = $292,377.96

b)

Amount for lessor for break even = $292,377.96

Calculation of amount for lessee for break even:

NAL = cost of asset - PMT * PVIFA(8.3%, 3 years)
0 = $750,000 - PMT * 2.56321
PMT = $750,000 / 2.56321 = $292,601.83

Amount for lessee for break even = $292,601.83

Range = $292,377.96 to $292,601.83