Uminum, the world's largest producer of feldspar, is considering leasing a sifter that costs $450,000. The 5-year lease requires 5 beginning-of-the-year payments. The leasing company is depreciating the sifter on a straight-line basis of $90,000 per year to a salvage value of zero but assumes the actual salvage value at the end of 5 years is expected to be $25,000. If the leasing company desires to earn an 11% after-tax rate of return of the lease, what annual lease payment will they require? Assume a marginal tax rate of 40%.
A) $125,145
B) $75,087
C) $148,517
D) $122,736

Question

Quizplus · Accepted Answer

The correct answer is A because the annual lease payment is $125,145. The leasing company's after-tax cost of debt is 6.6% [11% x (1 - 40%)]. The present value of the lease payments is $563,153 [$125,145 x 4.50263]. The present value of the salvage value is $12,500 [$25,000 x 0.5]. The present value of the tax savings on the lease payments is $21,865 [$125,145 x 0.4 x 4.50263]. The total present value of the lease is $597,518 [$563,153 + $12,500 + $21,865]. The annual lease payment is $125,145 [$597,518 / 4.77908].

Uminum, the World's Largest Producer of Feldspar, Is Considering Leasing