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 common practice with expensive, high-tech equipment). The scanner costs $9,000,000, and it would be depreciated straight-line to zero over three years. Because of radiation contamination, it will actually be completely valueless in three years. Assume that the tax rate is 35 percent. You can borrow at 12 percent before taxes.

What would the lease payment have to be for both the lessor and the lessee to be indifferent about the lease? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Break-even lease payment $_______

Explanation / Answer

Solution:

The aftertax cost of debt is:

Aftertax debt cost = .12(1 – .35) = .078

Depreciation tax shield = ($9,000,000/3)(.35) = $1,050,000

To find the maximum lease payment that would satisfy both the lessor and the lessee, we need to find the payment that makes the NAL equal to zero. Using the NAL equation and solving for the OCF, we find:

NAL = 0 = $9,000,000 – OCF(PVIFA7.80%,3)

OCF = $3,479,705.76

The OCF for this lease is composed of the depreciation tax shield cash flow, as well as the aftertax lease payment. Subtracting out the depreciation tax shield cash flow we calculated earlier, we find:

Aftertax lease payment = $3,479,705.76 – 1,050,000 = $2,429,705.76

Since this is the aftertax lease payment, we can now calculate the breakeven pretax lease payment as:

Breakeven lease payment = $2,429,705.76/(1 – .35) = $3,738,008.87

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