A firm is considering leasing a printing machine.The lease lasts for 3 years.The lease calls for 3 payments of $4,000 per year with the first payment occurring immediately.The machine would cost $7,500 to buy and would be straight-line depreciated (tax purpose)to zero salvage value over 3 years.The firm can borrow at 5%, and has a corporate tax rate is 30%.What is the NPV of the lease?
A)$1,482
B)- $2,838
C)- $654
D)- $1,552
E)None of the above

Question

Quizplus · Accepted Answer

First, let's calculate the cost of buying the machine:

Depreciation per year = (Cost - Salvage value) / Useful life = (7500 - 0) / 3 = 2500
Tax savings per year = Depreciation per year * Tax rate = 2500 * 0.3 = 750
After-tax cost of owning = Cost - Tax savings = 7500 - 750 = 6750

Now, let's calculate the cost of leasing:

Lease payments per year = 3 * 4000 = 12000
After-tax cost of leasing = Lease payments - Tax savings on lease payments = 12000 - (12000 * 0.3) = 8400

The NPV of the lease can be calculated as follows:
PV(outflows) = present value of lease payments = $8,400
PV(inflows) = present value of tax savings on lease payments and purchase = $750(PMT, 5%, 3 years) + $2,500(PMT, 5%, 3 years) = $2,837.69
NPV = PV(inflows) - PV(outflows) = $2,837.69 - $8,400 = -$5,562.31

Since the NPV of leasing is negative, it's not a good choice, and buying the machine is the better option. Therefore, the best choice is to buy the machine.

A Firm Is Considering Leasing a Printing Machine