National Rail can purchase equipment for $386,000 that would be depreciated using the MACRS rates of 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent for Years 1 to 4, respectively. The equipment will be worthless after four years. The equipment can be leased for four years at $110,500 a year. The firm can borrow at 8 percent and has a tax rate of 21 percent. What is the net advantage to leasing?

Question

Quizplus · Accepted Answer

To calculate the net advantage to leasing, we need to find the after-tax cost of leasing and compare it to the after-tax cost of purchasing.

For leasing: 
Total lease cost over 4 years = 4 x $110,500 = $442,000 
After-tax lease cost = Total lease cost x (1 - tax rate) = $442,000 x (1 - 0.21) = $349,580

For purchasing: 
Depreciation in Year 1 = $386,000 x 33.33% = $128,670 
Depreciation in Year 2 = $386,000 x 44.44% = $171,820 
Depreciation in Year 3 = $386,000 x 14.82% = $57,198 
Depreciation in Year 4 = $386,000 x 7.41% = $28,599 
Total depreciation over 4 years = $386,000 
Tax savings due to depreciation = Total depreciation x tax rate = $386,000 x 0.21 = $81,060 
After-tax cost of purchasing = Cost of purchasing - Tax savings due to depreciation = $386,000 - $81,060 = $304,940

The net advantage to leasing is the difference between the after-tax cost of leasing and the after-tax cost of purchasing: 
Net advantage to leasing = After-tax lease cost - After-tax cost of purchasing = $349,580 - $304,940 = $44,640

Therefore, the net advantage to leasing is $44,640. The best choice is C, which is closest to the calculated value.

National Rail Can Purchase Equipment for $386,000 That Would Be