Question

Suppose Amazon is considering the purchase of computer servers and network infrastructure to expand its very successful business offering​ cloud-based computing. In​ total, it will purchase

$ 48.9$48.9

million in new equipment. This equipment will qualify for accelerated​ depreciation:

20 %20%

can be expensed​ immediately, followed by

32 %32%​,

19.2 %19.2%​,

11.52 %11.52%​,

11.52 %11.52%​,

and

5.76 %5.76%

over the next five years.​ However, because of the​ firm's substantial loss carryforwards and other​ credits, Amazon estimates its marginal tax rate to be

10 %10%

over the next five​ years, so it will get very little tax benefit from the depreciation expenses.​ Thus, Amazon considers leasing the equipment instead. Suppose Amazon and the lessor face the same

7.7 %7.7%

borrowing​ rate, but the lessor has a

35 %35%

tax rate. For the purpose of this​ question, assume the equipment is worthless after five​ years, the lease term is five​ years, and the lease qualifies as a true tax lease.

a. What is the lease rate for which the lessor will break​ even?

b. What is the gain to Amazon with this lease​ rate?

c. What is the source of the gain in this​ transaction?

Answer 1

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