Delmont Transport Company (DTC) is evaluating the merits of leasing versus purch

Question

Delmont Transport Company (DTC) is evaluating the merits of leasing versus purchasing a truck with a 4-year life that costs $40,000 and falls into the MACRS 3-year class. If the firm borrows and buys the truck, the loan rate would be 10%, and the loan would be amortized over the truck's 4-year life, so the interest expense for taxes would decline over time. The loan payments would be made at the end of each year. The truck will be used for 4 years, at the end of which time, it will be sold at an estimated residual value of $10,000. If DTC buys the truck, it would purchase a maintenance contract that costs $1,000 per year, payable at the end of each year. The lease terms, which include maintenance, call for a $10,000 lease payment at the beginning of each year (i.e. 4 payments total). DTC's tax rate is 40%.

          

           What is the net advantage to leasing?

           (Note: Assume MACRS rates for Years 1 to 4 are 0.3333, 0.4445, 0.15, and 0.07.)

Explanation / Answer

PV of cash flows under buying option

PV of cash flows under lease option

PV of cash flow is less under lease option, advantage is $ 2,617

Cost Depreciation rate Depreciation per year 40000 0.3333                13,332 40000 0.4445                17,780 40000 0.15                   6,000 40000 0.07                   2,800

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