Jamestown Industries is contemplating the acquisition of some new equipment. The purchase price is $40,000. The equipment has a 4-year life after which time it will be worthless. The equipment belongs in a 35 percent CCA class. The equipment can be leased for $11,000 a year. The firm can borrow money at 7 percent and has a 35 percent tax rate. What is the incremental annual cash flow for year 2 if the company decides to lease the equipment rather than purchase it?

Question

Quizplus · Accepted Answer

The incremental annual cash flow for year 2 if the company decides to lease the equipment rather than purchase it is -$11,193. This is because the company would save $11,000 in lease payments, but would have to pay $7,904 in additional taxes on the depreciation deduction. The net savings would be $11,000 - $7,904 = $3,096. However, the company would also have to pay $4,000 in interest on the loan used to purchase the equipment. This would result in a net incremental cash flow of $3,096 - $4,000 = -$11,193.

Jamestown Industries Is Contemplating the Acquisition of Some New Equipment