Russo Industries is considering the purchase of some new equipment costing $84,000. This equipment has a 3-year life after which it will be worthless. The ﬁrm uses straight-line depreciation
And borrows funds at a 10 percent rate of interest. The company's tax rate is 34 percent. The ﬁrm
Also has the option of leasing the equipment. What is the amount of the break-even lease payment?

Question

Quizplus · Accepted Answer

The break-even lease payment is calculated by determining the after-tax cost of owning the equipment, which includes depreciation tax shields and interest tax shields, and equating it to the after-tax cost of leasing. The calculation involves finding the annual depreciation ($84,000/3 = $28,000), calculating the tax shield on depreciation ($28,000 * 34% = $9,520), and the interest tax shield on the loan ($84,000 * 10% * 34% = $2,856). The total annual after-tax cost of owning is $28,000 - $9,520 + $8,400 - $2,856 = $23,024. The break-even lease payment is the pre-tax lease payment that results in the same after-tax cost, which is $23,024 / (1 - 0.34) = $34,897.

Russo Industries Is Considering the Purchase of Some New Equipment