Spingboro Industries can either lease or buy some equipment. The lease payments would be $16,000 a year. The purchase price is $54,900. The equipment has a 3-year life after which it is
Expected to have a resale value of $9,000. The ﬁrm uses straight-line depreciation over the asset's
Life, borrows money at 8.75 percent, and has a 35 percent tax rate. What is the incremental cash
ﬂow for year 1 if the company decides to lease the equipment rather than purchase it?

Question

Quizplus · Accepted Answer

Leasing Option:
Lease payment = $16,000
Tax savings on lease payment = $16,000 * 0.35 = $5,600
Incremental cash flow = -$16,000 + $5,600 = -$10,400

Buying Option:
Depreciation per year = ($54,900 - $9,000) / 3 years = $15,300
Interest expense = $54,900 * 0.0875 = $4,806.75
Tax savings from depreciation and interest expense = ($15,300+$4,807) * 0.35 = $6,027.45
Incremental cash flow = -$54,900 + $9,000 + $6,027.45 = -$39,872.55

Comparing the two options, the incremental cash flow for leasing is lower than the incremental cash flow for buying, so the best choice is to lease the equipment.

Spingboro Industries Can Either Lease or Buy Some Equipment