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. What lease payment will make the lessee and the lessor equally well off? (Do not round intermediate calculations and round your final answers to 2 decimal places, (e.g., 32.16)) Lease payment 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 NPVfor 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

Explanation / Answer

a) The answer is $ 297,549

For both the parties to be equally well off it is that lease rent for which their NPV is equal.

Since the tax rates of both the parties is the same their perspectives are exactly opposite; ie their cash flows will be exactly opposite. Hence the lease payment for one which makes his NPV zero will be appropriate for the other also.

Now, for finding out the lease payment for which NPV for the lessor is '0" can be calculated as under:

L = 532000/1.78794 = 297549

b) Since the lessors tax rate is unchanged the 0 NPV for hime results from the L = 297549

But of the lessee the tax rate is nil and his 0 NPV is obtained by solving the equation

0=600000 + L *PVIFA(3.3,3) = 600000 + 2.8124 L

L =600000/2.8124 =$213340

So the range is 213340 to 297549

NPV for lessor = Cost + aftertax PV(lease payments) + Pv of Depreciation Tax Shield After tax disount rate = 8.66 = 5.28% Depreciation tax shield = 600000/3   * .34 = 68000 Setting NPV = 0 and solving for L 0=600000 - 0.66*L*PVIFA(5.28,3) + 68000 532000 = .66*2.7090*L

L = 532000/1.78794 = 297549

b) Since the lessors tax rate is unchanged the 0 NPV for hime results from the L = 297549

But of the lessee the tax rate is nil and his 0 NPV is obtained by solving the equation

0=600000 + L *PVIFA(3.3,3) = 600000 + 2.8124 L

L =600000/2.8124 =$213340

So the range is 213340 to 297549

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