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 $6.3 million and it qualifies for a 30% CCA rate. Because of radiation contamination, it is valueless in four years. You can lease it for $1.915 million per year for four years. You can borrow at 10.0% pre-tax. Assume that the assets pool remains open and payments are made at the end of the year.

Assume that your company does not contemplate paying taxes for the next several years. What are the cash flows from leasing?

Answer 1

Since there is no tax to be paid for the next few years, the annual after-tax cash flow from leasing is the same as the lease payment which is 1,915,000.

Net advantage to leasing (NAL) = equipment cost - lease cost*(1-Tax)*PVIFA(k, n) - CCA tax shield - Present Value of salvage value

Since tax is zero, there is no CCA tax shield.Salvage value is also zero.

k (after-tax cost of debt) = 10%; n (life) = 4

NAL = 6,300,000 - 1,915,000*(1-0%)*PVIFA(10%,4) = 6,300,000 - 1,915,000*3.1699

= 229,707.67 or 229,708

Cash flow from leasing is simply 1,915,000 p.a. (as there is no tax to be paid)