Question

Carolina Trucking Company (CTC) is evaluating a potential lease for a truck with a 4-year life that costs $41,000 and falls into the MACRS 3-year class. If the firm borrows and buys the truck, the loan rate would be 9.6%, and the loan would be amortized over the truck's 4-year life. The loan payments would be made at the end of each year. The truck will be used for 4 years, at the end of which it will be sold at an estimated residual value of $12,800. If CTC buys the truck, it would purchase a maintenance contract that costs $1,900 per year, payable at the end of each year. The lease terms, which include maintenance, call for a $10,000 lease payment (4 payments total) at the beginning of each year. CTC's tax rate is 35%. What is the net advantage to leasing? (Note: MACRS rates for Years 1 to 4 are 0.33, 0.45, 0.15, and 0.07.) Do not round your intermediate calculations.

Answer 1

Answer: Net advantage of leasing : $ 3,561

Discount rate = i * ( 1 - t ) = 9.6 % x 0.65 = 6.24 %

NPV of Purchase:

Year	0	1	2	3	4
Initial Investment	(41,000)
Depreciation rate		0.33	0.45	0.15	0.07
Depreciation Expense		13,530	18,450	6,150	2,870
Maintenance Expense		(1,900)	(1,900)	(1,900)	(1,900)
Tax savings on Maintenance Expense		665	665	665	665
Tax savings of Depreciation Expense		4,736	6,458	2,153	1,005
Operating cash flows after taxes		3,501	5,223	918	(230)
After tax salvage proceeds ( 12,800 x 0.65 )					8,320
Net cash flows	(41,000)	3,501	5,223	918	8,090
PV factor at 6.24 %	1.0000	0.9413	0.8860	0.8339	0.7850
Present Values	(41,000)	3,295.49	4,627.58	765.52	6350.65
Net Present Value ( NPV )	(25,960.76)

NPV of Lease :

	1	2	3	4
Lease payments	(10,000)	(10,000)	(10,000)	(10,000)
Tax savings	3,500	3,500	3,500	3,500
Net cash flows	(6,500)	(6,500)	(6,500)	(6,500)

Present value of lease payments at 6.24 % for 4 years = ( 6,500) x 3.4461 = (22,399.65)

Net advantage of leasing = $ 3,561.11