Question

# Precision Tool is trying to decide whether to lease or buy some new equipment for its...

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

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

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