Question

Company X wants to establish a lease for an asset that has a market price of $ 500,000 and a 5-year tax life. The term of the contract is 5 years and the annual rent is $ 220,000. In addition, the contract stipulates that company X will purchase the asset at the end of year 5 at a price of $ 30,000. If the credit opening expenses are $ 5,000, the tax rate is 50% 'and the average annual inflation for the coming years is 15%' what is the cost of this lease without considering and taking into account inflation ?

Answer 1

We know that the market price of the asset is $500,000

And the lease agreement has annual lease rent of $220,000 with the credit opening expenses of $5,000 and $30,000 at the end of the lease period for the purchase of asset.

The cost of lease is equal to the discount rate at which the present value of cashflows involved in lease are equal to the market price of the asset i.e. $500,000

CFAT = $220,000 - Tax @ 50% = $110,000

At 6%, the present value of cashflows of lease

$5,000 + ($110,000 * 4.21) + ($30,000 * 0.75)

=$490,600

At 5%, the present value of cashflows of lease

$5,000 + ($110,000 * 4.32) + ($30,000 * 0.8)

=$503,600

Cost of lease = 5% + (3,600 / 13,000)

Cost of lease = 5.28%