Ft. Myers Marina can lease $31,800 of equipment for $7,200 a year for five years. If purchased, the equipment would be depreciated over its 5-year life and then have a resale value of $5,900. The firm uses straight-line depreciation, borrows at 8 percent, and has a tax rate of 21 percent. What is the net advantage to leasing?

Question

Quizplus · Accepted Answer

First, let's calculate the cost of purchasing the equipment:

Purchase cost = $31,800 - $5,900 = $25,900

Depreciation per year = $25,900 / 5 years = $5,180 per year

After-tax cost of debt = 8% * (1 - 21%) = 6.32%

Annual depreciation tax shield = $5,180 * 21% = $1,087.80 per year

Net cost of purchasing = ($5,180 - $1,087.80) * 5 years = $18,962

Now, let's calculate the cost of leasing:

Lease cost = $7,200 * 5 years = $36,000

Net advantage to leasing = Cost of purchasing - Cost of leasing = $18,962 - $36,000 = -$17,038

Since the net advantage to leasing is negative, it is not the best choice. Therefore, purchasing the equipment would be a better choice.

Ft Myers Marina Can Lease $31,800 of Equipment for $7,200