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 $5,400,000 and it would be depreciated straight-line to zero over five years. Because of radiation contamination, it actually will be completely valueless in five years. You can lease it for $1,340,000 per year for five years.

  

The tax rate is 24 percent. You can borrow at 8 percent before taxes. What is the NAL of the lease from the lessor's viewpoint? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

We will calculate cash flows from the depreciation tax shield first.

The depreciation tax shield is:

Depreciation tax shield = ($5,400,000/5)(.24) = $259,200

The after-tax cost of the lease payments will be:

After-tax lease payment = ($1,340,000)(1 – .24) = $1,018,400

So, the total cash flows from leasing are:

OCF = $259,200 + 1,018,400 = $1,277,600

The after-tax cost of debt is:

After-tax debt cost = .08(1 – .24) = .0608

Using all of this information, we can calculate the NAL as:

NAL = $5,400,000 – $1,277,600 (PVIFA6.08%,5) = $29976.21

The NAL is positive so you should lease