Question

Your firm is considering leasing a storage box. The lease lasts for three years. The lease calls for three payments of $1,350 per year with the first payment occurring at lease inception. The storage box would cost $3,600 to buy and would be straight-line depreciated to zero salvage value over three years. The firm can borrow at 6 percent, and the marginal corporate tax rate is 30 percent. What is the NPV of the lease? (You don’t have to use the table if you don’t find it helpful). (a) $30.50 (b) -$30.50 (c) -$65.75 (d) -$117.52 (e) -$93.65

Answer 1

NPV of lease = cost of storage box - Present value of (after tax lease payments + tax shield of depreciation)

it is given first payment occurs at inception of lease so first paymet is  at t = 0

lease payments = 1350

tax = 30%

so after tax lease payments = 1350*(1 - 0.3) = 945

Deprecation = 3600 / 3 = 1200

tax shield = 1200*30% = 360

cash flows will be as follows

at (t = 0) = 945 (only lease payments)

at (t = 1) = 945 + 360 = 1305 (both lease payment and depreciation)

at (t = 2) = 945+360 = 1305(both lease payment and depreciation)

at (t = 3) = 360 (only depreciation)

discount rate = 6% (before tax)

after tax = 6*(1 - 0.3) = 4.2%

present value of cash flows = [945 / (1+4.2%)^0] + [1305 / (1+4.2%)^1] + [1305 / (1+4.2%)^2 ] + [360 / (1+4.2%)^3]

= 3717.52

so NPV = 3600 - 3717.52 = -$117.52

Option (d) is correct.