Uptown Stores is contemplating the acquisition of some new equipment. The purchase price is $52,000. The equipment would be depreciated using 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 would be worthless after that time. The equipment can be leased for $14,000 a year for 4 years. The firm can borrow money at 9 percent and has a 35 percent tax rate. What is the incremental annual cash flow for year 3 if the company decides to lease the equipment rather than purchase it?
A) -$13,417
B) -$11,797
C) -$9,840
D) -$7,597
E) -$6,528

Question

Quizplus · Accepted Answer

The incremental cash flow for leasing rather than purchasing is calculated by considering the after-tax cost of leasing and the tax shield from depreciation. In year 3, the depreciation tax shield is $52,000 * 14.82% * 35% = $2,698.44. The after-tax lease cost is $14,000 * (1 - 0.35) = $9,100. The incremental cash flow is the negative of the difference: -($9,100 - $2,698.44) = -$11,797.

Uptown Stores Is Contemplating the Acquisition of Some New Equipment