Deep Mining, Inc., is contemplating the acquisition of some new equipment for co

Question

Deep Mining, Inc., is contemplating the acquisition of some new equipment for controlling coal dust that costs $174,000. The firm uses MACRS depreciation which allows for 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively. After that time, the equipment will be worthless. The equipment can be leased for $53,100 a year for 4 years. The firm can borrow money at 11.5 percent and has a 36 percent tax rate. What is value of the lease?

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Explanation / Answer

Generally lease payments are at the beginning of year but as nothing mentioned, we can assume at the end of the year.

Cost of borrowing = 11.5%

After-tax cost of borrowing = 11.5*(1 - 0.36) = 7.36%

After-tax annual lease value = 53,100*(1 - 0.36) = 33,984.00

Let me know for any discrepancies.

Owning 0 1 2 3 4 Equipment cost -174,000.00 MACRS 33.33% 44.44% 14.82% 7.41% Depreciation 57,994.20 77,325.60 25,786.80 12,893.40 Tax saving on depreciation 36% 20,877.91 27,837.22 9,283.25 4,641.62 Loan principal 174,000.00 -174,000.00 Loan interest (after-tax) -12,806.40 -12,806.40 -12,806.40 -12,806.40 Cash flow 0.00 8,071.51 15,030.82 -3,523.15 -182,164.78 PV of owning @ 7.36% -119,406.31 Leasing Cash flow -33,984.00 -33,984.00 -33,984.00 -33,984.00 PV of leasing @ 7.36% -114,181.63 NAL (PV of leasing - PV of owning) 5,224.68

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