Question

Your firm is considering leasing a new computer. The lease lasts for 8 years. The lease calls for 8 payments of $8,000 per year with the first payment occurring immediately. The computer would cost $50,000 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 firm can borrow at a rate of 5%. The corporate tax rate is 34%. What is the after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in year 0?

$50,000

$44,720

$42,000

-$37,650

-$8,000

Answer 1

Leasing

Cash flow from leasing = 8000 + 8000*PVAF(5%,7)

= $ 54290

Tax saving of such lease payment = 8000*34%

= 2720

PV of tax saving = 2720 * PVAF (5%,8)

= $17580

Cash flow from leasing at year 0 = 54290-17580

= $36710

BUYING

Initial cash out flow = $50000

Tax shield on depreciation = 50000 / 8 * 34%

= $2125

PV of tax shield = 2125*6.463

= $ 13733.8

Cash flow from buying = $50000 - 13733.8

= $ 36266.2

Note - both the situation are analysed in detail. for query ask for help in comment section