Thomas Corporation is evaluating whether to lease or purchase equipment. Its tax

Question

Thomas Corporation is evaluating whether to lease or purchase equipment. Its tax rate is 30 percent. The company expects to use the equipment for 5 years, with no expected salvage value. The purchase price is $1 million and MACRS depreciation, 3-year class, will apply.       If the company enters into a 5-year lease, the lease payment is $230,000 per year, payable at the beginning of each year. If the company purchases the equipment it will borrow from its bank at an interest rate of 11 percent.  

a. Calculate the cost of purchasing the equipment.

Cost of equipment $1,000,000 MACRS depreciation                  0.33 0.45 0.15 0.07 5-year lease Lease payment -BGN year $230,000 Loan 11% Tax rate 30% After-tax rate 7.70%

Explanation / Answer

cost of leasing

lease payment= 230000

less tax saved =     69000(230000*30%)

lease payment=   161000

PV of lease=161000+(161000*3.334)=697774

purchase option

purchase price=1000000

int.=                    550000 (110000*5)

tax saved on int and depreciation

1. (1000000*.33*30%) +110000*30%=99000+33000

2.(1000000*.45*30%)+110000*30%=135000+33000

3.(1000000*.15*30%)+110000*30%=150000+33000

4.(1000000*.07*30%)+110000*30%=70000+33000

5.110000*30%= 33000

total=465000

PV of int=110000*4.02=442692.82

PV of tax

saved@ 7.7%=392746.4165

purchase option payment=1000000+442692.82-392746.4165=1049946.40

as the payment of lease is less than purchase option lease should be selected.

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.