Question

Problem 21-3 Finding the Break-Even Payment

You work for a nuclear research laboratory that is contemplating leasing a diagnostic scanner (leasing is a common practice with expensive, high-tech equipment). The scanner costs $8,210,000, and it would be depreciated straight-line to zero over five years. Because of radiation contamination, it will actually be completely valueless in five years. Assume that the tax rate is 35 percent. You can borrow at 14 percent before taxes.

What would the lease payment have to be for both the lessor and the lessee to be indifferent about the lease? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

       

Break-even lease payment

$

Answer 1

The aftertax cost of debt would be 0.14*(1-0.35)			9.10%
We will have to find the payment which makes the net advantage of leasing (NAL) equal to zero
NAL = Cost of asset - Operating cash flow*PVIFA(9.10%,5)
0 = 8,210,000 - OCF*PVIFA(9.10%,5)
OCF = 8,210,000/3.87958
OCF = $2,116,208.56
The OCF would also include the tax shield on depreciation and the lease payment would be after tax
The tax shield on depreciation = (8210000/5)*0.35			$574,700
Therefore after tax lease payment = 2116208.56-574700
After tax lease payment	$1,541,508.56
The breakeven lease payment before tax = 1,541,508.56/(1-0.35)
Break even lease payment	$2,371,551.63
The break even lease payment is $2,371,661.63