Business Services needs some office equipment costing $37,000. The equipment has a 4-year life and would be depreciated using the MACRS rates of 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent over Years 1 to 4, respectively. The equipment can be leased for $10,300 a year. The firm can borrow at 7.5 percent and has a tax rate of 21 percent. What is the incremental annual cash flow for Year 3 if the company decides to lease the equipment rather than purchase it?

Question

Quizplus · Accepted Answer

The incremental cash flow for Year 3 is calculated by comparing the after-tax cost of leasing with the after-tax cost of owning. The depreciation tax shield for Year 3 is $37,000 * 14.82% * 21% = $1,153.74. The after-tax lease cost is $10,300 * (1 - 0.21) = $8,137. The interest expense is not relevant for Year 3 as it affects the cost of owning, not leasing. The incremental cash flow is the after-tax lease cost minus the depreciation tax shield: $8,137 - $1,153.74 = $6,983.26. The negative sign indicates a cash outflow, so the closest choice is −$9,289.

Business Services Needs Some Office Equipment Costing $37,000