Lester's can purchase a new machine for $128,000. The machine has a 4-year life and can be sold at the end of year 4 for $12,000. Lester's uses MACRS depreciation which allows for 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively. The equipment can be leased for $30,500 a year. The firm can borrow money at 8.8 percent and has a 34 percent tax rate. The company does not expect to owe any taxes for at least the next 5 years due to accumulated net operating losses. What is the incremental annual cash flow for year 4 if the company decides to lease rather than purchase the equipment?

Question

Quizplus · Accepted Answer

The incremental annual cash flow for year 4 if the company decides to lease rather than purchase the equipment is -$42,500. This is because the company would save $30,500 in lease payments, but would also have to pay $12,000 in taxes on the sale of the equipment. The net savings would be $18,500, which is then discounted back to year 4 using the 8.8% interest rate to get -$42,500.

Lester's Can Purchase a New Machine for $128,000