Question

Branard Industrial Equipment Corporation (BIEC) is in view of leasing the new Machine which requires, for $155,000 a year, which is payable in advance. The cost of the Machine is $900,000 has a Cost of Capital Allowance rate of 25% and will last for 72 months. The expected salvage value is $150,000. Assume that the first Capital Cost Allowance tax deduction would be taken at the end of the first year. BIEC has lots of other Machine in this asset pool. The tax rate is 30% and the cost of debt is 7%. What is the maximum annual lease payment that would make BIEC indifferent between leasing or buying? (5 points)

Answer 1

		ANNUAL COST OF BUYING:
		Cost of machine	$900,000
		Year	1	2	3	4	5	6
	A	Book Value at Beginning of year	$900,000	$675,000	$506,250	$379,688	$284,766	$213,574
	B=A*25%	Depreciation	$225,000	$168,750	$126,563	$94,922	$71,191	$53,394
	C=A-B	Book Value at End of year	$675,000	$506,250	$379,688	$284,766	$213,574	$160,181
	D=B*30%	Depreciation Tax Shield	$67,500	$50,625	$37,969	$28,477	$21,357	$16,018
	E	Salvage Value at end of year 6						$150,000
	F=C-E	Loss on salvage						$10,181
	G=F*30%	Tax saving due to loss						$3,054
	H=E+G	Cash Flow due to salvage						$153,054
		Present Value (PV) of Cash Flow:
		(Cash Flow)/((1+i)^N)
		i=Discount Rate= Cost of debt=7%=0.07
		N=Year of Cash Flow
	N	Year	0	1	2	3	4	5	6
	A	Cost of machine	($900,000)
	B	Depreciation Tax shield		$67,500	$50,625	$37,969	$28,477	$21,357	$16,018
	C	Salvage Cash Flow							$153,054
	D=A+B+C	Net Cash Flow	($900,000)	$67,500	$50,625	$37,969	$28,477	$21,357	$169,072	SUM
	PV=D/(1.07^N)	Present Value of Net Cash flow	($900,000)	$63,084	$44,218	$30,994	$21,725	$15,228	$112,660	($612,092)
	PW	Present Worth of Cost of Buying	$612,092
	PMT	Annual After tax equivalent cost	$120,013	( Using PMT function of excel with Rate=7%,Nper=6, Pv=-612092, Type=1)
				(Type=1,because cost is calculated based on beginning of year cost)
	PMT/(1-0.3)	Annual Before tax cost	$171,448
		Annual Lease payment that makes BIEC indifferent between BUYING & LEASING	$171,448