Rosewood Furniture is considering purchasing equipment costing $69,000 which it expects to sell at the end of Year 4 for $22,500. The firm uses MACRS depreciation with rates of 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent over Years 1 to 4, respectively. The equipment can be leased for $18,800 a year for four years. The firm can borrow at 7.5 percent and has a tax rate of 21 percent. What is the incremental annual cash flow for Year 4 if the company decides to lease the equipment rather than purchase it?

Question

Quizplus · Accepted Answer

To calculate the incremental annual cash flow for Year 4 when the company decides to lease rather than purchase, we need to consider the after-tax salvage value, the after-tax lease payment, and the depreciation tax shield for Year 4.1. **Salvage Value**: The equipment is sold for $22,500 at the end of Year 4. The tax benefit from the sale is calculated as the difference between the sale price and the book value, multiplied by the tax rate. The book value at the end of Year 4 is the initial cost minus the total depreciation. Total depreciation over 4 years is $69,000 * (33.33% + 44.44% + 14.82% + 7.41%) = $69,000. Thus, the book value at the end of Year 4 is $69,000 - $69,000 = $0. The entire sale price is a gain, so the tax on the sale is $22,500 * 21% = $4,725. The after-tax salvage value is the sale price minus the tax, which is $22,500 - $4,725 = $17,775.2. **Lease Payments**: The after-tax cost of the lease payments for Year 4 is the lease payment multiplied by (1 - tax rate), which is $18,800 * (1 - 0.21) = $18,800 * 0.79 = $14,852.3. **Depreciation Tax Shield for Year 4**: The depreciation in Year 4 is $69,000 * 7.41% = $5,113.29. The tax shield is the depreciation multiplied by the tax rate, which is $5,113.29 * 21% = $1,073.79.The incremental cash flow for Year 4 is the after-tax salvage value plus the depreciation tax shield minus the after-tax lease payments. Therefore, the incremental cash flow is $17,775 + $1,073.79 - $14,852 = $3,996.79.However, since the options provided do not match the calculated value, it's possible there was a misunderstanding in the calculation process or an error in the interpretation of the question's requirements. Given the options, the correct approach involves comparing the cost of leasing to the benefits of owning, including the salvage value and depreciation benefits. The mistake might be in not properly accounting for all aspects of the question or a calculation error. Without the correct option matching the detailed calculation, it's crucial to reevaluate the steps or consider if additional information or a different calculation method is required for this specific question.

Rosewood Furniture Is Considering Purchasing Equipment Costing $69,000 Which It