Prime Care has approached the leasing department of First City Bank to arrange lease financing for a $1.2 million CAT scanner. The economic life of the scanner is estimated to be 10 years. The estimated salvage value at the end of 10 years is $0. First City plans to depreciate the scanner on a straight-line basis over 10 years. If First City charges a beginning-of-the-year lease payment of $255,395, what after-tax rate of return will the bank earn on the lease? Assume a marginal tax rate of 40%.
A) 4.7%
B) 16.8%
C) 13%
D) 40%

Question

Quizplus · Accepted Answer

To calculate the after-tax rate of return, we need to calculate the total lease payments over the life of the lease and subtract the cost of the scanner.

Total lease payments = $255,395 x 10 = $2,553,950
Cost of scanner = $1.2 million

Therefore, the bank's income from the lease is $2,553,950 - $1,200,000 = $1,353,950.

The after-tax rate of return is the rate that makes the present value of the income equal to the cost of the scanner. Using a financial calculator, the after-tax rate of return is approximately 13%.

Therefore, the best choice is C.

Prime Care Has Approached the Leasing Department of First City