The First National Bank of Springer has established a leasing subsidiary. A loca
ID: 2654063 • Letter: T
Question
The First National Bank of Springer has established a leasing subsidiary. A local firm, Allied Business Machines, has approached the bank to arrange lease financing for $10 million in new machinery. The economic life of the machinery is estimated to be 20 years. The estimated salvage value at the end of the 20-year period is $0. Allied Business Machines has indicated a willingness to pay the bank $1 million per year at the end of each year for 20 years under the terms of a financial lease.
a. If the bank depreciates the machinery on a straight-line basis over 20 years to a $0 estimated salvage value and has a 40 percent marginal tax rate, what after-tax rate of return will the bank earn on the lease?
b. In general, what effect would the use of MACRS depreciation by the bank have on the rate of return it earns from the lease?
Explanation / Answer
b. If the bank uses MACRS depreciation , the rate of return on the lease will be more----as in the initial years the depreciation is more and hence tax savings (on non-cash expense) will be more.Tax advantages reduce in the latter years, because of the reduced depreciation .So overall rate of return is more.-taking into consideration time value of money.
a.Value of machinery 10000000 Life in yrs. 20 Depreciation p.a. 500000 Tax savings@40% p.a. 200000Related Questions
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