Uptown Stores is contemplating the acquisition of some new equipment. The purchase price is $52,000. The equipment would be depreciated using MACRS depreciation which allows for 33.33
Percent, 44.44 percent, 14.82 percent, and 7.41 percent depreciation over years 1 to 4, respectively.
The equipment would be worthless after that time. The equipment can be leased for $14,000 a year
For 4 years. The ﬁrm can borrow money at 9 percent and has a 35 percent tax rate. What is the
Incremental annual cash ﬂow for year 3 if the company decides to lease the equipment rather than
Purchase it?
A) -$13,417
B) -$11,797
C) -$9,840
D) -$7,597
E) -$6,528

Question

Quizplus · Accepted Answer

If the company decides to lease the equipment, it would have an incremental annual cash outflow of $14,000 for each of the 4 years.
If the company decides to purchase the equipment, the annual depreciation expense for year 3 would be:
Year 1: $52,000 x 33.33% = $17,316.00
Year 2: $52,000 x 44.44% = $23,115.20
Year 3: $52,000 x 14.82% = $7,697.60
Year 4: $52,000 x 7.41% = $3,849.60
Total: $51,978.40
The tax savings from the depreciation expense would be:
$51,978.40 x 35% = $18,192.44
The net cash outflow for year 3 would then be:
Purchase price: -$52,000
Tax savings: +$18,192.44
Net cash outflow: -$33,807.56
Comparing the two options, the incremental annual cash flow for year 3 would be:
Lease: -$14,000
Purchase: -$33,807.56
Incremental cash flow: +$19,807.56
Therefore, the company would have a positive incremental cash flow if it decides to purchase the equipment instead of leasing it.

Uptown Stores Is Contemplating the Acquisition of Some New Equipment