Question

Corporate Finance

You work for a nuclear research laboratory that is contemplating leasing a diagnostic scanner (leasing is a very common practice with expensive, high-tech equipment). The scanner costs €4,800,000, and it would be depreciated straight-line to zero over four years. Because of radiation contamination, it actually will be completely valueless in four years. You can lease it for €1,430,000 per year for four years. You can borrow at 8 percent before taxes. Assume that the tax rate is 21 percent.

Question:

Create a lease-versus-buy analysis. Calculate the NPV of leasing. Should you lease or buy?

Answer 1

Post tax Discounting rate = 8 × (1-0.21) = 6.32%

Buying option

Initial outflow = € 4,800,000

Annual cashflow

Depreciation = 4,800,000/4 = 1,200,000

Tax benefit on depreciation(21%) = 252,000

Cumulative discounting factor (6.32 %, 4 yrs) = 3.439865

PV of annual saving = 252,000× 3.439865

= 866,846

NPV of buying option = - 4,800,000 + 866,846

= - € 3,933,154

Leasing option

Annual lease. = € 1,430,000

Less: Tax 21% . = (300,300)

Post tax outflow = 1,129,700

NPV of leasing option = -1,129,700 × 3.439865

= - € 3,886,015

Leasing should be preferred as PV of cost is less in leasing option