Q3 can purchase an equipment for $35,000 or lease it from L3 for 5 annual lease
ID: 2744244 • Letter: Q
Question
Q3 can purchase an equipment for $35,000 or lease it from L3 for 5 annual lease payments (paid at the beginning of the year) of $7,500. The equipment has CCA rate of 20% and will have salvage value of $2,000 at the end of year 5. Both companies do not have any other asset in the asset class. Q3’s cost of debt is 6% which is 2% higher than L3’s. The tax rates for Q3 and L3 are 30% and 40% respectively.
a. Calculate the NPV of leasing for Q3 and L3.
b. What is the range of annual lease payment that makes leasing acceptable to both Q3 and L3?
Explanation / Answer
Calculation of NPV of Leasing for Q3 and L3 :
Q3 :
Cost of debt after tax = 4.2% ( 6 - 30%)
Present value 5 annual lease payments = $7500 * PVAF@4.2%,5years
= $7500 * 4.61285
= $34596.38
Value of the machine = $33000 (Net of salvage value)
NPV = ($14596.38)
L3 :
Cost of debt after tax = 2.4% (4%- 40%)
Present value of 5 lease payments = $7500 * 4.771054
= $35782.90
Salvage value of the machine = $2000 * 0.888
= $1776.36
NPV = (35782.90+1776.36) - 35000
= $2560
Calculation of Range of annual lease payments :
Q3 = $7153.93 ** (33000 / 4.61285)
L3 = $6963.58 ** ((35000 - 1776.96) / 4.771054)
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