MIG Tools can either lease or buy some equipment. The lease payments would be $12,800 a year and the purchase price is $35,900. The equipment has a 3-year life after which it is expected to have a resale value of $5,000. The firm uses 100 percent bonus depreciation, borrows money at 8 percent, and has a tax rate of 21 percent. What is the incremental cash flow for Year 1 if the company decides to lease the equipment rather than purchase it?

Question

Quizplus · Accepted Answer

The incremental cash flow for Year 1 when leasing instead of purchasing includes the lease payment, tax shield from depreciation, and interest expense. The lease payment is $12,800. The tax shield from depreciation is $35,900 * 21% = $7,539. The interest expense on the loan is $35,900 * 8% = $2,872. The net cash flow is $12,800 - $7,539 + $2,872 = $8,133. The incremental cash flow is the negative of this amount, which is -$17,651.

MIG Tools Can Either Lease or Buy Some Equipment