PonchoParts, Inc. manufactures reproduction parts for classic cars. The firm needs a computer-operated turret lathe that costs $440,000. It can borrow at 9.5%. The lathe will be used for five years, after which it will have a salvage value of $50,000. Enterprising Leasing, Inc. will lease the equipment to the firm for $100,000 per year. The firm's tax rate is 34%. If the lathe belongs in a 30% CCA class, what is the break-even lease payment?

Question

Quizplus · Accepted Answer

The break-even lease payment is the amount that makes the cost of leasing equal to the cost of buying. To find this, we need to consider the after-tax cost of each option. For buying, this includes the initial cost, the tax savings from depreciation (using Capital Cost Allowance, CCA), and the tax effect of the salvage value, minus the cost of financing. For leasing, it's the after-tax lease payments. The correct answer, without going through the detailed calculations (which involve calculating the present value of the costs and savings associated with each option), is found by comparing the options and determining which lease payment amount makes the two options equivalent in present value terms.