A manager has decided to buy a widget. Two alternative financing methods are ava
ID: 2759264 • Letter: A
Question
A manager has decided to buy a widget. Two alternative financing methods are available: (A) use a financial lease or (B) purchase the widget using owner financing and borrowed capital. The financial lease is a 3 year lease with annual lease payments of $6,500 paid at the beginning of each year (a lease payment is tax deductible; assume it can be claimed at the beginning of each year). The manager can buy the widget for $20,000 and sell it again in 3 years for $5,000. A bank will loan $15,000 and the loan will be fully amortized at 10% over 3 years with annual payments. The IRS will allow the widget to be depreciated over 10 years. The marginal tax rate is 15%. The manager requires at least a 10% pre-tax return on capital. Assume that the inflation rate is 0%. Should the manager buy or lease?
QUESTION 1
What is the after-tax discount rate?
10%
8.5%
15%
3%
None of the above
10 points
QUESTION 2
What is the after-tax lease payment (absolute value)?
$0
$15,310
$5,525
$2,000
None of the above
10 points
QUESTION 3
What is the annual depreciation if you lease the widget (absolute value)?
$0
$15,310
$5,525
$2,000
None of the above
10 points
QUESTION 4
What is the tax savings from depreciation if you lease the widget (absolute value)?
$0
$15,310
$5,525
$2,000
None of the above
10 points
QUESTION 5
What is the present value of the lease payment (absolute value)?
$0
$15,310
$5,525
$2,000
None of the above
10 points
QUESTION 6
What is the net present value of leasing the widget (absolute value)?
$0
$15,310
$5,525
$2,000
None of the above
10 points
QUESTION 7
What is the annuity equivalent of leasing the widet (absolute value)?
$0
$15,310
$5,525
$5,995
None of the above
10 points
QUESTION 8
What is the after-tax terminal value if you purchase the widget (absolute value)?
$6,000
$6,350
$1,700
$2,000
None of the above
10 points
QUESTION 9
What is the annual depreciation if you purchase the widget (absolute value)?
$6,000
$6,350
$1,700
$2,000
None of the above
10 points
QUESTION 10
What is the accumulated depreciation over the first three years if you purchase the widget (absolute value)?
$6,000
$6,350
$1,700
$2,000
None of the above
10 points
QUESTION 11
What is the annual tax savings from depreciation if you purchase the widget (absolute value)?
$6,000
$6,350
$1,700
$2,000
None of the above
10 points
QUESTION 12
What is the present value of the after-tax terminal value if you purchase the widget (absolute value)?
$14,262
$5,584
$766
$4,971
None of the above
10 points
QUESTION 13
What is the present value of the tax savings from depreciation if you purchase the widget (absolute value)?
$14,262
$5,584
$766
$4,971
None of the above
10 points
QUESTION 14
What is the net present value of purchasing the widget (absolute value)?
$14,262
$5,584
$766
$4,971
None of the above
10 points
QUESTION 15
What is the annuity equivalent of purchasing the widet (absolute value)?
$14,262
$5,584
$766
$4,971
None of the above
10 points
QUESTION 16
Leasing the Widget has a lower cost so you would choose to lease the Widget?
True
False
10%
8.5%
15%
3%
None of the above
Explanation / Answer
1) The after tax discount rate will be = pretax discount*(1-tax rate )
= 10%*(1-15%)
=10%*(1-.15)
=10%*(.85)
=8.5%
hence option B
2) After tax lease payment would be :
lease payment post tax = pretax *(1-tax rate)
=6500*(1-.15)
=6500*(.85)
=$5525
hence option C
3) If you lease the widget then the company cannot claim depreciation hence the depreciation will be $0
hence option A
4) When there is no depreciation to be charged when lease payment is used then there is no concept of taxx savings on the depreciation.
hence option A= $0
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