Howell Auto Parts is considering whether to borrow funds and purchase an asset o

Question

Howell Auto Parts is considering whether to borrow funds and purchase an asset or to lease the asset under an operating lease arrangement.If the company purchases the asset, the cost will be $10,000. It can borrow funds for four years at 12%. The firm will use the three year MACRS depreciation category(with the associated 4-year write off). Assume a tax rate of 35%


A. Compute the after tax cost of borrow-purchase alternative.
B.Compute the present value of the aftertax cost of the two alternatives. Use a discount rate of 8%
C.Which alternative should be selected, based on miimizing the present value of aftertax costs?

Explanation / Answer

year

payment

interest

depreciation

Tax deductions

Tax shield

Net after tax

1

3293

1200

3350

4530

1586

1707

2

3293

949

4450

5399

1890

1403

3

3293

668

1480

2148

752

2541

4

3293

353

740

1093

383

2910

B.Compute the present value of the aftertax cost of the two alternatives. Use a discount rate of 8%

year

Afer tax

Cost of leasing

Pv

Factor 8%

Present value

After cost borrow purchase

Pv

Factor 8%

Present value

1

1690

.926

1565

1707

.926

1581

2

1690

.857

1448

1403

.857

1202

3

2990

.794

2374

2541

.794

2018

4

2990

.735

2198

2910

.735

2139

7585

6940

C.Which alternative should be selected, based on miimizing the present value of aftertax costs?

The borrow and purchase decision has a lower present value and would be selected based on that criteria . Other factors may also be considered

year

payment

interest

depreciation

Tax deductions

Tax shield

Net after tax

1

3293

1200

3350

4530

1586

1707

2

3293

949

4450

5399

1890

1403

3

3293

668

1480

2148

752

2541

4

3293

353

740

1093

383

2910

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