Question

Marshall Corporation is considering leasing a new equipment. The lease lasts for 8 years. The lease calls for 8 payments of $102,000 per year with the first payment occurring immediately. The equipment would cost $680,000 to buy and would be straight-line depreciated to a zero salvage value over 8 years. The actual salvage value is negligible because of technological obsolescence. The actual pre-tax salvage value is $34,000. The firm can borrow at a rate of 7.2%. The corporate tax rate is 25%. What would the NPV of the lease relative to the purchase be?

		-$10,981.57
		-$14,300.87
		$15,296.51
		$12,416.58
		$17,319.72

Answer 1

Solution :

The NPV of the lease relative to the purchase if the asset had a pretax salvage value of $ 34,000 is = $ 15,296.51

Thus the solution is option 3 = $ 15,296.51

The discount rate used in the solution is the after tax discount rate.

As per the information given in the question we have

Discount rate = 7.2 % ; Tax rate = 25 % = 0.25

Thus, after tax discount rate = Discount rate * ( 1 - Tax rate )

= 7.2 % * ( 1- 0.25 ) = 7.2 % * 0.75 = 5.4 %

Please find the attached screenshot of the excel sheet containing the detailed calculation for the above solution.