Storage tanks to hold a highly corrosive chemical are currently made of material

Question

Storage tanks to hold a highly corrosive chemical are currently made of material Z26. The capital investment in a tank is $31,000, and its useful life is eight years. Your company manufactures electronic components and uses the ADS under MACRS to calculate depreciation deductions for these tanks. The net MV of the tanks at the end of their useful life is zero. When a tank is four years old, it must be relined at a cost of $12,000. This cost is not depreciated and can be claimed as an expense during year four. Instead of purchasing the tanks, they can be leased. A contract for up to 20 years of storage tank service can be written with the Rent-All Company. If your firm's after-tax MARR is 14% per year, what is the greatest annual amount that you can afford to pay for tank leasing without causing purchasing to be the more economical alternative? Your firm's effective income tax rate is 39%. The greatest annual amount that you can afford to pay is $.

Explanation / Answer

Leasing is a rental agreement . The break-even lease rental is the rental at which the lessee is indifferent to the choice between the option of leasing and buying and borrowing. At this level Net advantage of leasing (NAL) is zero .In this way it represents the maximum lease rental which the lessee is willing to pay and helps in determining lease rentals.

Benefits from Lease = Cost of the equipment + present value of tax shield on lease rentals

PV of Lease rentals =Equipment cost

Let the break even lease rental be ‘x’ such that:

X * PVIFA (14%, 20)=31000

Or, x *6.6231 = 31000

Or, X = 31000/6.6231

Or, X= 4680.58

Or x= 4681 (rounded off)

Hence, the answer.

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