Aldo, Inc. is trying to decide whether to lease or buy some new equipment. The equipment costs $59,000, has a 3-year life, and belongs in a 25 percent CCA class. The equipment will be worthless
After the 3 years and will have to be replaced. The company has a tax rate of 34 percent and a cost
Of borrowed funds of 10 percent. The equipment can be leased for $22,000 a year. What is the
Amount of the annual depreciation tax shield in the ﬁrst year?

Question

Quizplus · Accepted Answer

The annual CCA rate for a 25 percent class is 25% x $59,000 = $14,750. In the first year, the depreciation expense would be $14,750 x 1/2 = $7,375 (assuming half-year rule). The annual depreciation tax shield would then be $7,375 x 34% = $2,508.

To determine whether to lease or buy, we need to compare the after-tax cost of each option.

Buying:
Year 0: - $59,000 (equipment cost)
Year 1: - $7,375 (depreciation expense) + $2,508 (tax shield)
Year 2: - $14,750 (depreciation expense) + $5,015 (tax shield)
Year 3: - $14,750 (depreciation expense) + $5,015 (tax shield)
Total cost over 3 years: $59,000 - $2,508 + $5,015 + $5,015 = $66,522

Leasing:
Year 1: -$22,000 (lease cost)
Year 2: -$22,000 (lease cost)
Year 3: -$22,000 (lease cost)
Total cost over 3 years: $66,000

Based on the calculations, buying is the better choice as it results in a slightly lower total cost over the 3-year period.

Aldo, Inc Is Trying to Decide Whether to Lease or Buy