Ajax Leasing Services has be approached by Gamma Tools to provide lease financin

Question

Ajax Leasing Services has be approached by Gamma Tools to provide lease financing for a new automated screw machine. The machine will cost $220,000 and will be leased by Gamma for five years. Lease payments will be made at the beginning of each year. Ajax will depreciate the machine on a straight line basis of $44,000 per year down to a book salvage value of $0. The actual salvage value is estimated to be $30,000 at the end of the five years. Ajax’s marginal tax rate is 40%. Ajax desires to earn a 12% after-tax return on this lease. What are the required annual beginning-of-year lease payments?

Explanation / Answer

Calculation of amount to be amortized:
   Initial outlay =$220,000 Less: Present value of $18,000 after-tax

salvage value at 12% ($18,000 x 0.567) = $10,206 Less: Present value of annual depreciation

tax shelter ($44,000 x 0.4 x 3.605) =$63,448

Amount to be amortized =$146,346

Calculation of annual after-tax lease income required to be received by lessor:

   Amount to be amortized :

$146,346 = R(PVIFA.12,5)(1.12)
$146,346 = R(3.605)(1.12)
   R = $36,246
Calculation of lease payment required from lessee:
   Required lease payment = $36,246/(1 - 0.4) = $60,410

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