New Tech Industries is negotiating a lease on a new piece of equipment that woul

Question

New Tech Industries is negotiating a lease on a new piece of equipment that would cost $100,000 if purchased. The equipment falls into the MACRS 3-year class, and it would be used for 3 years and then sold, because New Tech plans to move to a new facility at that time. The applicable MACRS depreciation rates are 0.33, 0.45, 0.15, and 0.07. It is estimated that the equipment could be sold for $30,000 after 3 years of use. A maintenance contract on the equipment would cost $3,000 per year, payable at the beginning of each year of usage. Conversely, New Tech could lease the equipment for 3 years for a lease payment of $29,000 per year, payable at the beginning of each year. The lease would include maintenance. New Tech is in the 20 percent tax bracket, and it could obtain loan to purchase the equipment at a before-tax cost of 10 percent. Is it a Net Advantage to Leasing or to purchasing and what is the amount of the advantage?

Explanation / Answer

The cost of capital or WACC = 10*(1-0.2) = 8% (After tax)

We calculate the NPV of purchasing :

The NPV of leasing is :

The Net advantage to leasing = -59,788.65 - (-89,976.38) = $30,187.73

Year 0 1 2 3 Initial Cash flow -100000 Annual Maintenance -3000 -3000 -3000 Depreciation -33000 -45000 -15000 Tax savings on Main& Dep. 7200 9600 3600 Profit after tax -28800 -38400 -14400 Add back Dep. 33000 45000 15000 Net cash flow -100000 4200 6600 600 NPV of Purchase at 8% $ -89,976.38

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