Question

Greencore Corporation is considering leasing a new equipment. The lease lasts for 8 years. The lease calls for 8 payments of $225,000 per year with the first payment occurring immediately. The equipment would cost $1,480,000 to buy and would be straight-line depreciated to a zero salvage value over 8 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 6%. The corporate tax rate is 25%. What is the after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in year 6?

		-$225,000
		-$220,000
		-$215,000
		-$185,000
		None of the above

Answer 1

Correct answer: -$215,000

Tax rate = 25%

Annual Lease payment = $225,000

After-tax Annual Lease payment = 225,000*(1-0.25) = $168,750

Equipment cost to buy = $1,480,000

Life in years = 8

Annual depreciation = 1,480,000/8 = $185,000

Tax shield on depreciation = 185,000*0.25 = $46,250

Thus,

After-tax cash flows for lease in year-6 = -$168,750

and,

After-tax cash flows for Buy in year-6 = $46,250

The after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in year 6: