The L Company is considering a new office computer system. They can purchase the
ID: 2740188 • Letter: T
Question
The L Company is considering a new office computer system. They can purchase the system for $15,000. If the computer system is purchased, it will be depreciated straight line over a five year life to a zero salvage value. However, they estimate that it could be sold for $4,000 at that time. Alternatively, L Company could lease the computer system for six payments of $2,800, with the first payment due immediately. L Company's before tax cost of debt is 9% and its marginal tax rate is 34%. The cost of leasing minus the cost of purchasing is:
a.$926
b.-$132
c.-$311
d.$1,249
Explanation / Answer
After tax cost of leasing = 2800 (1-.34) = 1848
After tax cost of debt = 9 (1-.34) = 5.94%
present value of cost of debt =PVAF@5.94%,6, After tax cost of lease
= 5.21925 * 1848
= $ 9645.17
Purchase:
Depreciation = cost /life = 15000/5= 3000
Tax shield on depreciation = 3000 *.34 = 1020
Present value of tax shield = PVAF@5.94%,5 * tax shiield
= 4.21925 * 1020
= 4303.63
After tax salvage value = 4000 (1-.34 ) = 2640
present value of After tax salvage value =Pvf@5.94%,5 * after tax salvage
= .74938* 2640 = $ 1978.35
Net cost of purchase =cash outflow -cash inflow
= 15000-1978.35 - 4303.63 = 8718.02
cost of leasing -cost of purchase = 9645.17 -8718.02 = 927.15
correct option is "A" = 926 [approx ,error to decimals in present value factors ]
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