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 common practice with expensive, high-tech equipment). The scanner costs $6,900,000, and it would be depreciated straight-line to zero over four years. Because of radiation contamination, it will actually be completely valueless in four years. You can lease it for $1,935,000 per year for four years. Assume that the tax rate is 35 percent. You can borrow at 10 percent before taxes. Calculate the NAL. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) NAL Should you lease or buy? Buy Lease

Explanation / Answer

Calculation of cash flows from depreciation and tax lease payment :

              Depreciation tax shield                =    (6,900,000/4)(35%)         =    $603,750

            After tax lease payment               =     (1,935,000)(1-0.35)          = $1,257,750

Total cash flow from lease                   = ($603,750+$1,257,750)        =   $1,861,500

Calculation of after tax debt of tax :

                         After tax debt cost      = (0.10)(1-0.35)     =0.065

   Calculation of NAL :

                   NAL =     $6,900,000-$1,861,500(PVIFA AT 6.5% for 4 years)

                            =      $6,900,000-$1,861,500(3.4650)

                 NAL          =   $449,902.5

Net Advantage Lease (NAL) is positive so you should lease

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