a. Based on the information given, is it advantageous for both A1 Corp.to lease

Question

a. Based on the information given, is it advantageous for both A1 Corp.to lease the machine and for B2 Inc. to purchase the asset in order to lease it out to A1?

b. If the answer in part a is yes, then what is the maximum lease payment which A1 will pay and the minimum rental which B2 will accept?

A1 Corp. is considering leasing an machine from B2, Inc.   Cost of Machine 1,000,000 Depreciation 5-year MACRS method with 0 residual value Lease term (in years) 6 Lease Payment 200000 at the beginning of years 0, 1, …, 5. Tax Rate for A1 0.0% A1 has tax-loss which prevents it from additional tax shield Tax Rate for B2 40.0% A1 Cost of Borrowing 10.0% B2 Cost of Borrowing 7.0%

Explanation / Answer

Soln : First Let's talk about B2, if he will buy it and give it on lease to A1. Please refer here the table of Cash flows of the 6 years:

We have seen the NPV for B2 = 81069.32, for B2 it is there to buy the machine.

In case if A1 would buy the machine, AW = 1000000*(A/P,10%,6) = 229607.40

While if he will lease the AW = 200000, so leasing is good option for them.

b) Now, for B2 minimum rental should make the NPV =0 . So, in the table put the values of lease payments to get the NPV = 0 in excel

We will get the value = 177225, please refer the table below

Max. Lease payment A1 can give is 229607,as it is the value in case if A1 is purchasing the machine.

Year 0 1 2 3 4 5 6 Depreciation% as per MACRS 20% 32% 19.20% 11.52% 11.52% 7.41% Cost of Machine 1000000 Lease payment received 200000 200000 200000 200000 200000 200000 Depreciation 200000 320000 192000 115200 115200 74100 Net cash flow 200000 0 -120000 8000 84800 84800 -74100 Tax rate 80000 0 -48000 3200 33920 33920 -29640 As the profit is to be carry forward in case if negative Tax to be paid 80000 0 0 0 0 23040 0 Net cash flow 120000 0 -120000 8000 84800 61760 -74100 Discount rate is 7%, facor,F 1 0.93 0.87 0.82 0.76 0.71 0.67 PV 120000 0 -104813 6530.383 64693.51 44034.03 -49376 NPV 81069.32

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