Edith Aviation is considering leasing or purchasing a small aircraft to transpor

Question

Edith Aviation is considering leasing or purchasing a small aircraft to transport executives between manufacturing facilities and the main administrative headquarters. The firm is in the 40 percent tax bracket and its after-tax cost of debt is 7 percent. The estimated after-tax cash flows for the lease and purchase alternatives are given below: Year 1 Lease = -64,329 Purchase= -68,454 Year 2 Lease= -64,329 Purchase= -59,110 Year 3 Lease= -64,329 Purchase= -63,596 Year 4 Lease= -64,329 Purchase= 66,633 Year 5 Lease= 64,329 Purchase= 30,056 (a) Given the above cash outflows for each alternative, calculate the present value of the after-tax cash flows using the after-tax cost of debt for each alternative. (b) Which alternative do you recommend? Why?

Explanation / Answer

a.The present value of cash flows for leasing is as shown below:

The present value of cash flows for buying is as shown below:

b. Since the present value of cash flows of purchase is higher, we recommend the purchase alternative

Lease Year Cash flow Discounted Cash flow at 7% 1 -64239 -60036.45 2 -64329 -56187.44 3 -64329 -52511.63 4 -64329 -49076.29 5 64329 45865.69 Present value of cash flows $                             -1,71,946.11

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