Marsden Travels Limited is considering a leasing arrangement to acquire new computers and office furniture. Marsden's before-tax short-term borrowing rate is 5.5%, its before-tax long-term borrowing rate is 7%, its tax rate is 35% and the lessor's implied discount rate is 6%. Which of the following rates should Marsden use in its analysis of the lease-or-purchase issue?
A) Its before-tax long-term borrowing rate
B) The lessor's implied discount rate
C) Its after-tax long-term borrowing rate
D) Its before-tax short-term borrowing rate

Question

Quizplus · Accepted Answer

When evaluating a lease versus purchase decision, it is important to use the after-tax cost of borrowing. Therefore, Marsden should use its after-tax long-term borrowing rate, which is 4.55% (7% * (1-35%)) in its analysis. Option A (before-tax long-term borrowing rate) and option B (lessor's implied discount rate) are both incorrect because they do not take into account Marsden's tax rate. Option D (before-tax short-term borrowing rate) is also incorrect because it is a short-term rate and the lease is for new computers and office furniture, which are capital assets.

Marsden Travels Limited Is Considering a Leasing Arrangement to Acquire