You work for a nuclear research laboratory that is contemplating leasing a diagn

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 $6,000,000, and it would be depreciated straight-line to zero over three years. Because of radiation contamination, it will actually be completely valueless in three years. Assume the tax rate is 35 percent. The borrowing rate is 6 percent before taxes. Your company does not expect to pay taxes for the next several years, but the leasing company will pay taxes. Over what range of lease payments will the lease be profitable for both parties? (Enter your answers from lowest to highest. Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))

Total payment range

Explanation / Answer

1. We will calculate cash flows from the depreciation tax shield first. The depreciation tax shield is:

Depreciation tax shield = ($6,000,000/3)(.35) = $700,000

2. Then we will calculate After Tax Cost of Debts. = 6% x (1-0.35) =3.9%

3. Cost of Scanner= $6,000,000

Cost of Scanner = $ 6,000,000

Less : PV of Tax benefit on Depreciation= 700000 x PVIFA (3.9%, 3yr.) = 700000 x 2.78037 = ($1,946,259)

Amount = 6,000,000-1,946,259 = 4053741

Break Even Lease Rental for Lessor (After Tax) = 4,053,741 / 2.78037 = 1,457,986

Break Even Lease Rental Fore Lessor (Before Tax) = 1,457,986 / (1-0.35) = 2,243,055

2. PV of Post tax Interest Payment =234,000 x 2.78037 =650,607

Pv of Principal Repayment (at end of 3rd Year) (assumed) = 4,762,993

Less : PV of Dep. Tax Shield = (1,946,259)

=> Cost of Borrowing = 650607+4762993-1946259 =3467341

Break Even Lease Rental for Lessee (after tax)= 3467341 / 2.78037 = 1,247,079

Break Even Lease Rental For Lessee (before tax) = 1247079 / (1-0.35) = 1,918,583

So, Range of Lease Rental Profitable to both parties is 1,918,583 - 2,243,055

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