Question

Acme Packing Company is evaluating whether its new equipment should be purchased for $4,365 or leased for $1,394 for 6 years with payments made at the beginning of each year. The firm pays 7% on its debt and faces a tax rate of 25%. The tax benefits are assumed to occur evenly throughout the year (use the mid-year approximation). What is the total net cost of leasing the equipment (in present value terms)? Although the net cost will represent a cash outflow, present your answer as a positive number.

Answer 1

The cost is computed as follows:

Net cost of each year will be as follows:

= $ 1,394 x (1 - 0.25)

= $ 1,045.5

discount rate will be as follows:

= 7% x (1 - 0.25)

= 5.25% or 0.0525

So, the cost will be as follows:

= $ 1,045.5 + $ 1,045.5 / 1.0525¹ + $ 1,045.5 / 1.0525² + $ 1,045.5 / 1.0525³ + $ 1,045.5 / 1.0525⁴ + $ 1,045.5 / 1.0525⁵

= $ 1,045.5 + $ 993.3491686 + $ 943.7996852 + $ 896.7217911 + $ 851.9922006 + $ 809.4937773

= $ 5,540.86 Approximately

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