An asset costs $300,000 and will be depreciated in a straight-line manner over i

Question

An asset costs $300,000 and will be depreciated in a straight-line manner over its three-year life. It will have no salvage value. The lessor can borrow at 4 percent and the lessee can borrow at 7 percent. The corporate tax rate is 34 percent for both companies.

a. What lease payment will make the lessee and the lessor equally well off? (Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16)) Lease payment $ ?

b. Assume that the lessee pays no taxes and the lessor is in the 34 percent tax bracket. For what range of lease payments does the lease have a positive NPV 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))

Lease payment $ to $ ?

Explanation / Answer

Taking 7% as the relevant Interest rate for part a.
Interest Rate = 7 x (1-0.34)= 4.62%

PV of Depreciation Tax Shield= (300000/3) x 0.34 x PVIFA (4.62%,3 yrs)
= 100000 x 0.34 x 2.7427 = 93252

Lease payment will make lessor and lessee equally well off if NAL(Net Advantage of Leasing)=0

=> NAL = 300000 - L x PVIFA (4.62%, 3yrs) - 93253
=> 0 = 300000 - L x 2.7427 -93253
=> L = 75380

b. Since Lessor has 34% tax Bracket
Its answer for range will be same as above part a.

& Since Leasee is No tax bracket, therefore we will take 7% as interest rate for calculation of Lease range.

For such a range calculation, NAL= 0
=> NAL = 300000- L x PVIFA (7%, 3 yrs)
=> 0 = 300000 - L x 2.6243
=> L = 114316

Thus, The range is 75380 - 114316 for having positive NPV for both parties.

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