Burton Enterprises is trying to determine if leasing would be a better alternative than purchasing $61,000 of new equipment. The equipment has a 4-year life after which time it will be worthless.
The equipment belongs in a 20 percent CCA class and can be leased for $16,000 a year. The ﬁrm
Can borrow money at 7.25 percent and has a 35 percent tax rate. What is the incremental annual
Cash ﬂow for year 2 if the company decides to lease the equipment rather than purchase it?
A) -$28,020
B) -$20,868
C) -$14,243
D) -$11,667
E) -$9,564

Question

Quizplus · Accepted Answer

The incremental cash flow for leasing involves comparing the after-tax cost of leasing with the after-tax cost of owning. The lease payment is $16,000 per year. The tax shield from leasing is $16,000 * 35% = $5,600. The after-tax lease cost is $16,000 - $5,600 = $10,400. For owning, calculate the CCA tax shield for year 2 using the declining balance method: CCA = $61,000 * 20% = $12,200 for year 1, and $61,000 - $12,200 = $48,800 * 20% = $9,760 for year 2. The tax shield is $9,760 * 35% = $3,416. The after-tax cost of owning is the interest on the loan minus the tax shield: $61,000 * 7.25% = $4,422.5 - $3,416 = $1,006.5. The incremental cash flow is $10,400 - $1,006.5 = $9,393.5, which is closest to option C.

Burton Enterprises Is Trying to Determine If Leasing Would Be