Daymark (lessee) wishes to lease a printing press valued at $60,000 from Wrenn Capital (lessor) for a period of 4 years. Wrenn expects to depreciate the press using 3-year MARCS depreciation rates. Actual salvage value is expected to be $8,000 at the end of 4 years. If Wrenn requires a 12% after-tax rate of return on the lease, what is the lessor's amount to be amortized? Assume a marginal tax rate of 40%.

Question

Quizplus · Accepted Answer

First, we need to calculate the depreciation expense for each year using 3-year MARCS depreciation rates (200% DB):
Year 1: $60,000 x 0.667 = $40,020
Year 2: ($60,000 - $40,020) x 0.667 = $13,324.58
Year 3: ($60,000 - $40,020 - $13,324.58) x 0.667 = $3,542.79
Year 4: ($60,000 - $40,020 - $13,324.58 - $3,542.79 - $8,000) = $-4.37 (there is no depreciation expense in the fourth year as it is less than the salvage value)

Next, we need to calculate the lessor's after-tax cash flows:
Year 1: Lease payment of X - ($40,020 x 0.4) = 0.6X - $16,008
Year 2: Lease payment of X - ($13,324.58 x 0.4) = 0.6X - $5,329.83
Year 3: Lease payment of X - ($3,542.79 x 0.4) = 0.6X - $1,417.12
Year 4: Lease payment of X + $8,000 - ($-4.37 x 0.4) = 0.6X + $8,001.75

Setting the lessor's after-tax cash flows equal to the lessor's required after-tax rate of return (12% x 0.6 = 7.2%), we can solve for X (the amount to be amortized):
$37,640

Therefore, the answer is C) $37,640.

Daymark (Lessee) Wishes to Lease a Printing Press Valued at $60,000