Question

You work for a nuclear research laboratory that is contemplating leasing a diagnostic scanner (leasing is a common practice with expensive, high-tech equipment). The scanner costs $7,210,000, and it would be depreciated straight-line to zero over five years. Because of radiation contamination, it will actually be completely valueless in five years. You can lease it for $1,975,000 per year for five years. Assume that the tax rate is 35 percent. You can borrow at 12 percent before taxes.

  

Calculate the NAL. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

NAL

$

   

Should you lease or buy?

	Lease
	Buy

Answer 1

Depreciation tax shield = ( 7210000/5 ) * 35%	504700
Lease payment ( after tax ) = 1975000*(1-35%)	1283750
Total cash flow from leasing = 504700 + 1283750	1788450
After tax cost of debt = 12%*(1-35%)	7.80%
Net advantage of leasing (NAL) = 7210000 - (1788450*PVAF,7.80%) = 7210000 - (1788450*(1-(1+7.80%)^-5)/7.80%)	31438.10

Should you lease or buy ?

Answer : Lease

Reason : As the NAL is positive we should lease