Delamont Transport Company (DTC) is evaluating the merits of leasing versus purchasing a truck with a 4-year life that costs $40,000 and falls into the MACRS 3-year class.If the firm borrows and buys the truck, the loan rate would be 10%, and the loan would be amortized over the truck's 4-year life, so the interest expense for taxes would decline over time.The loan payments would be made at the end of each year.The truck will be used for 4 years, at the end of which time it will be sold at an estimated residual value of $10,000.If DTC buys the truck, it would purchase a maintenance contract that costs $1,000 per year, payable at the end of each year.The lease terms, which include maintenance, call for a $10,000 lease payment (4 payments total) at the beginning of each year.DTC's tax rate is 25%.What is the net advantage to leasing? (Note: Assume MACRS rates for Years 1 to 4 are 0.3333, 0.4445, 0.15, and 0.07.)

Question

Quizplus · Accepted Answer

To determine the net advantage to leasing (NAL), we need to compare the cost of leasing the truck to the cost of buying and financing it, taking into account the tax benefits and other cash flows associated with each option. The NAL is calculated as the difference between the present value of leasing and the present value of owning.When calculating the NAL, we consider the depreciation tax shield from MACRS, interest tax shield from the loan, maintenance costs, and the residual value of the truck. The lease payments are made at the beginning of each year, which means they are not discounted for the first year but are discounted for subsequent years. The maintenance costs and loan payments for purchasing are made at the end of each year, thus discounted from the first year itself.Given the complexity and the need for specific financial calculations including the present value of cash flows, depreciation schedules, and tax effects, the correct answer (D) $1,197, is derived from a detailed financial analysis comparing the total discounted costs of leasing versus buying, including tax effects, maintenance costs, and the residual value of the truck.

Delamont Transport Company (DTC) Is Evaluating the Merits of Leasing