Question

Precision Tool is trying to decide whether to lease or buy some new equipment for its tool and die operations. The equipment costs $51,000, has a 3-year life and will be worthless after the 3 years. The pre-tax cost of borrowed funds is 7 percent and the tax rate is 35 percent. The equipment can be leased for $16,000 a year. What is the net advantage to leasing? (Do not round intermediate calculations.)

a. $4,831

b. $6,451

c. $6,097

d. $1,443

e. $3,710

Answer 1

Solution :

The Net advantage to leasing is = $ 6,096.78

= $ 6,097 ( when rounded off to a whole number )

Thus the solution is Option c. $ 6,097

Note :

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

As per the information given in the question we have

Pre - tax Discount rate = 7 % ; Tax rate = 35 % = 0.35

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

= 7 % * ( 1 - 0.35 ) = 7 % * 0.65 = 4.55 %

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