Breakstone, Inc. needs to acquire $280,000 worth of equipment. The equipment has a 5-year life and will be worthless after that time. This equipment belongs in a 35 percent CCA class and can be
Leased from Mangrove Leasing for $64,400 a year. Breakstone borrows money at 8.25 percent, and
Has suﬃcient tax loss carryovers to offset any potential taxable income the ﬁrm might have for the
Next ﬁve years. What is the net advantage to leasing?

Question

Quizplus · Accepted Answer

First, we need to calculate the depreciation expense for the equipment if it is purchased:
Total cost of equipment = $280,000
CCA rate = 35%
Year 1 Depreciation = $280,000 x 35% = $98,000
Year 2 Depreciation = ($280,000 - $98,000) x 35% = $67,900
Year 3 Depreciation = ($280,000 - $98,000 - $67,900) x 35% = $46,535
Year 4 Depreciation = ($280,000 - $98,000 - $67,900 - $46,535) x 35% = $31,349
Year 5 Depreciation = ($280,000 - $98,000 - $67,900 - $46,535 - $31,349) x 35% = $20,416
Total Depreciation Expense over 5 years = $264,200

Next, we need to calculate the after-tax cost of leasing:
Leasing cost = $64,400
After-tax leasing cost = $64,400 x (1- tax rate) = $64,400 x 0.65 = $41,860

Finally, we can calculate the net advantage to leasing:
Net Advantage to Leasing = Total Depreciation Expense - After-tax Leasing Cost
Net Advantage to Leasing = $264,200 - $41,860 = $222,340

Since the net advantage to leasing is positive, it is better to lease the equipment. The best choice is B.