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 9 percent and the tax rate is 34 percent. The equipment can be leased for $20,000 a year. What is the net advantage to leasing? (Do not round intermediate calculations.) $-2,177 $564 $210 $-1,056 $-4,444

Answer 1

Answer is $210

Cost of Equipment = $51,000
Useful Life = 3 years

Annual Depreciation = Cost of Equipment / Useful Life
Annual Depreciation = $51,000 / 3
Annual Depreciation = $17,000

Annual Lease Payment = $20,000

After-tax Lease Payment = Lease Payment * (1 - tax)
After-tax Lease Payment = $20,000 * (1 - 0.34)
After-tax Lease Payment = $13,200

Annual Depreciation Tax Shield = Depreciation * tax
Annual Depreciation Tax Shield = $17,000 * 0.34
Annual Depreciation Tax Shield = $5,780

After-tax Discount Rate = Pretax Discount Rate * (1 - tax)
After-tax Discount Rate = 9.00% * (1 - 0.34)
After-tax Discount Rate = 5.94%

Net Advantage to Leasing = $51,000 - $13,200 * PVIFA(5.94%, 3) - $5,780 * PVIFA(5.94%, 3)
Net Advantage to Leasing = $51,000 - $13,200 * 2.67598 - $5,780 * 2.67598
Net Advantage to Leasing = $210