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 very 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. Assume the tax rate is 35 percent. The borrowing rate is 10 percent before taxes. Your company does not expect to pay taxes for the next several years, but the leasing company will pay taxes. Over what range of lease payments will the lease be profitable for both parties? Total payment range

Explanation / Answer

From Lessee Point of View ( No taxes applicable)

Maximum Annual Lease Payment = Scanner Cost/((1-(1+r)^-n)/r)

Maximum Annual Lease Payment = 6900000/((1-(1+10%)^-4)/10%)

Maximum Annual Lease Payment = $ 2,176,748.55

From Lessor point of view

Annual Depreciation tax shield = 6900000/4*35% = 603750

Minimum annual lease payment*(1-tax rate) = Scanner Cost/((1-(1+r)^-n)/r) - Annual Depreciation tax shield

Minimum annual lease payment*(1-35%) = 6900000/((1-(1+10%)^-4)/10%) - 603750

Minimum annual lease payment* 65% = 2,176,748.55 - 603750

Minimum annual lease payment = $ 1572998.55/65%

Minimum annual lease payment = $ 2,419,997.77

Answer

Total Payment Range $ 2,419,997.77 to $ 2,176,748.55

Note: Leasing is not viable

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