Question

An asset costs $820,000 and will be depreciated in a straight-line manner over its three-year life. It will have no salvage value. The corporate tax rate is 24 percent and the appropriate interest rate is 9 percent.

    

a.	What would the lease payment have to be to make both the lessor and lessee indifferent about the lease? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
b.	Assume that the lessee pays no taxes and the lessor pays taxes. For what range of lease payments does the lease have a positive NPV for both parties? (Enter your answers from lowest to highest. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

Answer 1

a). For both lessor and lessee to be indifferent about the lease payment, the NAL has to be zero.

NAL = Cost of asset - PV of after-tax lease payments - PV of depreciation tax shield

Using excel Solver, solve for the lease payment for which NAL = 0, as follows:

Formulas:

At a lease payment of 323,617.60, both lessee and lessor will be indifferent to the payment.

b). If the lessee pays no tax then the depreciation tax shield is zero and the after-tax cost of debt equals the before-tax cost of debt (9%). Again, we solve for NAL = 0, using Solver, as follows:

Formulas:

lease payment = 323,944.90

Including the lease payment calculated in part (a), we get the following range of values for the lease payment. We have to check the NAL for both tables (in part a & b), for different values in the three ranges, to figure out for which range, both parties have a positive NAL.

< 323,617.60	+ive for lessor	+ive for lessee
323617.60 < x < 323944.90	-ive for lessor	+ive for lessee
> 323944.90	-ive for lessor	-ive for lessee

For values less than 323,617.60, both parties have a positive NAL.