6. Penn Medical Center, a taxpaying entity, is considering the purchase of a 64

Question

6. Penn Medical Center, a taxpaying entity, is considering the purchase of a 64 slice CT scanner. The cost the scanner is $4,000,000. The scanner would be depreciated over 10 years on a straight line basis to a zero salvage value. The tax rate is 40%. The financing options for the scanner are either borrowing the full value of the scanner or leasing the scanner. The lease is a five year lease with equal payments with a before tax lease payments of $950,000 per year. The borrowing opportunity is a five percent loan which is also the implied lease rate. The after tax cost of debt is three percent. Should Penn Medical lease the scanner or borrow the full amount to purchase it? Why? And, Show your calculations.

Explanation / Answer

Cost of scanner -4,000,000.00 Year 10 Depreciation         (400,000) Lease option: after tax lease payment         (570,000) -950000*(1-0.4) PV of annuity factor 5 yrs 5% 4.3295 Total cash outflow      (2,467,802) Purchase option: after tax Interest 3%         (120,000) (-4000000*3%) after tax Depreciation         (240,000) -400000*(1-.4) Total cost         (360,000) PV of annuity factor 10 yrs 5% 7.7217 Total cash outlfow      (2,779,825) As the total cash outflow is lesser in lease option , the asset should be taken on lease

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