Kohers Inc.is considering a leasing arrangement to finance some manufacturing tools that it needs for the next 3 years.The tools will be obsolete and worthless after 3 years.The firm will depreciate the cost of the tools on a straight-line basis over their 3-year life.It can borrow $4,800,000,the purchase price,at 10% and buy the tools,or it can make 3 equal end-of-year lease payments of $2,100,000 each and lease them.The loan obtained from the bank is a 3-year simple interest loan,with interest paid at the end of the year.The firm's tax rate is 40%.Annual maintenance costs associated with ownership are estimated at $240,000 payable at the end of the year,but this cost would be borne by the lessor if the equipment is leased.What is the net advantage to leasing (NAL),in thousands? (Suggestion: Delete 3 zeros from dollars and work in thousands.)

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Quizplus · Accepted Answer

The net advantage to leasing (NAL) is the present value of the tax savings from leasing minus the present value of the lease payments plus the present value of the maintenance costs that would be borne by the lessor if the equipment is leased.The present value of the tax savings from leasing is:PV(tax savings) = $2,100,000 x 0.40 x (1 - 1/(1 + 0.10)^3) = $554,400The present value of the lease payments is:PV(lease payments) = $2,100,000 x (1/(1 + 0.10)^1 + 1/(1 + 0.10)^2 + 1/(1 + 0.10)^3) = $5,102,400The present value of the maintenance costs that would be borne by the lessor if the equipment is leased is:PV(maintenance costs) = $240,000 x (1/(1 + 0.10)^1 + 1/(1 + 0.10)^2 + 1/(1 + 0.10)^3) = $576,000Therefore, the NAL is:NAL = PV(tax savings) - PV(lease payments) + PV(maintenance costs) = $554,400 - $5,102,400 + $576,000 = $106,000