Kitchen Remodelers needs to replace their pneumatic tools. The cost is $78,000 and the tools will be worthless after 4 years. The tools belong in a 20 percent CCA class and can be leased for $21,300 a year. The firm can borrow money at 10 percent. The firm does not expect to pay any taxes for the next 5 years. What is the net advantage to leasing?

Question

Quizplus · Accepted Answer

The net advantage to leasing (NAL) can be calculated by comparing the cost of leasing to the cost of buying. Since the firm does not expect to pay any taxes for the next 5 years, tax shields from CCA (Capital Cost Allowance) do not apply. Cost of leasing for 4 years = $21,300 * 4 = $85,200.Cost of borrowing to buy = $78,000 * (1 + 10%)^4 = $78,000 * 1.4641 = $114,159.8 (This is the future value of the loan after 4 years, but we need the present value of the cost of buying, which is simply the cost of the tools since the interest and depreciation are not tax-deductible in this scenario).The present value of leasing payments = $21,300 * [1 - (1 + 10%)^-4] / 0.10 = $21,300 * 3.169865 = $67,529.8.Net advantage to leasing = Cost of buying - Present value of leasing = $78,000 - $67,529.8 = $10,470.2.However, the calculation provided above does not match any of the options given, indicating a mistake in the calculation process. The correct approach involves comparing the present value of leasing to the cost of buying directly, considering the firm's borrowing rate as the discount rate for the lease payments.The correct calculation should factor in the depreciation benefits and the cost of capital properly. Given the error in the initial explanation and calculation, let's correct the approach based on the options provided:To find the NAL correctly, we should consider the cost of leasing versus the cost of buying, taking into account the time value of money at the firm's borrowing rate. However, without the tax considerations, the depreciation (CCA) does not provide a tax shield, simplifying the calculation.The correct approach involves calculating the present value of the lease payments and comparing it directly to the purchase price, considering the lack of tax implications simplifies the scenario but does not align with the initial incorrect calculation provided.Given the options and the mistake in the initial explanation, the correct answer should be recalculated based on the premise that the NAL is the difference between the present value of leasing and the cost of buying, considering the specific details of the scenario provided. However, without the correct calculations directly tied to the options, the initial answer choice (D) and explanation do not align with standard financial analysis methods for calculating NAL.

Kitchen Remodelers Needs to Replace Their Pneumatic Tools