Question

Spectrum Corporation is considering leasing a new equipment. The lease lasts for 8 years. The lease calls for 8 payments of $142,000 per year with the first payment occurring immediately. The equipment would cost $1,020,000 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 0?

$1,021,500

-$142,000

-$875,500

$913,500

$865,000

Answer 1

Year 0

Purchase cost of equipment saved.....1020000

First lease payment after-tax................-106500

(142000*(1-25%))

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Aftertax cash flow...................................913500

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Equipment is not purchased, if lease is taken. So $1020000 is saved at year 0.

So after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in year 0 is $913500