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 very common practice with expensive, high-tech equipment). The scanner costs $6,900,000, and it would be depreciated straight-line to zero over four years. Because of radiation contamination, it will actually be completely valueless in four years.

Assume the tax rate is 35 percent. The borrowing rate is 10 percent before taxes. Your company does not expect to pay taxes for the next several years, but the leasing company will pay taxes. Over what range of lease payments will the lease be profitable for both parties? (Enter your answers from lowest to highest. Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))    min-? max-?

Explanation / Answer

After Tax cost of Debt = Before tax borrowing rate*(1-tax rate)

From Lessor Point of View

After Tax cost of Debt = 10*(1-35%)

After Tax cost of Debt = 6.5%

At break even point

NAL = 0

Scanner Cost = Operating Cash flow*PVIFA(rate,nper)

Operating Cash flow = 6900000/PVIFA(6.5%,4)

Operating Cash flow = 6900000/3.425799

Operating Cash flow = $ 2,014,128.67

Annual Depreciation Tax shield= 6900000/4 * 35%

Annual Depreciation Tax shield= 603750

After Tax Lease Payment = Operating Cash flow - Annual Depreciation Tax shield

After Tax Lease Payment = 2014128.67-603750

After Tax Lease Payment = 1410378.67

Break Even Lease Payment required by lessor = After Tax Lease Payment /(1-tax rate)

Break Even Lease Payment required by lessor = 1410378.67/(1-35%)

Break Even Lease Payment required by lessor = $ 2,169,813.34

From Lessee Point of View

Annual Lease Payment = Scanner Cost/PVIFA(10%,4)

Annual Lease Payment = 6900000/3.169865

Annual Lease Payment = $ 2,176,748.85

Answer

$ 2,169,813.34 to $ 2,176,748.85

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