Suppose a company wants to decide whether to lease or purchase an asset. Purchas

Question

Suppose a company wants to decide whether to lease or purchase an asset.

Purchase: The capital cost required to purchase the asset is $1,000,000 (at time zero) with a salvage value of $500,000 at the end of the 5th year. The purchased asset can be depreciated based on MACRS 5-year life depreciation with the half year convention (table A-1 at IRS) over six years (from year 0 to year 5).

Lease: The asset can be leased for 5 years and annual lease payments (LP) of $250,000 (from year 1 to year 5). The asset would yield the annual revenue of $350,000 for five years (from year 1 to year 5) and operating cost of $60,000 for year 1 to 5.

Considering income tax of 35% and minimum ROR of 12%, calculate the ATCF and NPV for both alternatives and conclude which alternative is a better decision.

Explanation / Answer

After tax cash flows are calculated as

Leasing Buying Buying Buying 1-5 year 1st year 2-5 year 6 th year Revenue 350000 350000 350000 Operating cost 60000 60000 60000 Operating profits 290000 290000 290000 Leasing Cost 250000 Depreciation 50000 100000 50000 Net income before tax 40000 240000 190000 -50000 Tax 35 % 14000 84000 66500 0 After tax cash flow 26000 156000 123500 -50000

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.