Pressley's Inc. can purchase some equipment for $620,000 that has a life of four years, after which it will be worthless. The pretax cost of borrowed funds is 7.8 percent and the corporate tax rate is 21 percent. The firm expects significant operating losses for at least the next five years and thus expects to pay no taxes during this period. The equipment can be leased for $182,000 a year. What is the net advantage to leasing?

Question

Quizplus · Accepted Answer

The net advantage to leasing is the difference between the present value of the lease payments and the present value of the equipment purchase. The present value of the lease payments is $182,000 x 3.6299 = $660,809. The present value of the equipment purchase is $620,000 x 3.1699 = $1,965,538. Therefore, the net advantage to leasing is $660,809 - $1,965,538 = -$1,304,729.