Question

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 $3,000,000 and it would be depreciated straight-line to zero over 4 years. Because of radiation contamination, it will actually be completely valueless in 4 years. You can lease it for $900,000 per year for 4 years. Assume the tax rate is 31 percent. You can borrow at 7 percent before taxes.

What is after tax cost of lease payment? What is the annual depreciation tax shield? What is the annual operating cash flow from leasing? What is the after tax cost of debt? What is the net advantage to leasing (NAL) from your company's standpoint?

Answer 1

Answer :

After tax cost of lease payments = Lease payment * ( 1 - tax rate )

= $900,000 * ( 1 - 31% )

= $621,000

Annual depreciation tax shield = Depreciation * Tax rate

= ( $3,000,000 / 4 ) * 31%

= $232,500

Annual operating cash flow from leasing ( OCF ) = After tax cost of lease payments + Depreciation tax shield

= $621,000 + $232,500

= $853,500

After tax cost of debt = Cost of debt * ( 1 - tax rate )

= 7% * ( 1 - 31% )

= 4.83%

Net advantage to Leasing ( NAL ) = $3,000,000 - [ $853,500 * ( pvifa4.83%, 4 years ) ]

= $3,000,000 - [ $853,500 * { 1 - ( 1.0483)^(-4) } / 0.0483 ]

= - $38,458.44

As, NAL is negative, the scanner should not be leased.