An asset costs $600,000 and will be depreciated in a straight-line manner over i

Question

An asset costs $600,000 and will be depreciated in a straight-line manner over its three-year life. It will have no salvage value. The lessor can borrow at 5 percent and the lessee can borrow at 8 percent. The corporate tax rate is 34 percent for both companies.  

  

  

Assume that the lessee pays no taxes and the lessor is in the 34 percent tax bracket. For what range of lease payments does the lease have a positive NPV 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)) Lease payment ?$ to ?$ -?

An asset costs $600,000 and will be depreciated in a straight-line manner over its three-year life. It will have no salvage value. The lessor can borrow at 5 percent and the lessee can borrow at 8 percent. The corporate tax rate is 34 percent for both companies.  

Explanation / Answer

Finding the lease payment that gives NPV = 0 for one will be the answer for both:

Answer: (A)

Hence Lease Payment will be 220216.45

Answer (b)

For the Lessor NPV = Cost+After Tax PV (Lease Payments)+PV (Dep Tax Shield) Discount Rate 5% Tax Rate 34% After Tax Discount Rate: 5%*(1-0.34) 3.30% Asset Cost 600000 Salvage 0 Life 3 Depreciation Per Year: (600000/3) 200000 Depreciation Tax Shield: 200000*34% 68000 NPV = 0 = -600000 + 0.66 L*(PVIFA 3.30%,3Years)+ 68000*(PVIFA 3.30%, 3Years) NPV = 0 = -600000 + (0.66 L*2.812375)+ (68000*2.812375) NPV = 0 = -600000 + 1.856167 L+ 191241.49 1.856167 L= 600000-191241.49 1.856167 L= 408758.51 L = 408758.51/1.856167 L = 220216.45

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