A lessor will charge $13,800 a year for four years as lease payments on $47,800 of equipment. The equipment has a life of four years after which it should resell for $8,400. Your firm uses straight-line depreciation, borrows at 10 percent, and has a tax rate of 25 percent. What is the amount of the Year 4 cash flows when computing the NAL?

Question

Quizplus · Accepted Answer

To calculate NAL (Net Advantage to Lease), we need to calculate the present value of cash flows from leasing and owning and then take the difference between them.

Present value of lease payments = $13,800 x PVIFA(10%, 4) = $45,619.58

Present value of tax savings on lease payments = 25% x $13,800 x PVIFA(10%, 4) x 0.6 = $3,060.94 (as only 60% of lease payments are tax deductible)

Present value of cost of buying the equipment = $47,800

Present value of tax savings on depreciation = 25% x $39,000 (i.e. $47,800 - $8,400) x 0.6 = $5,850

Present value of resale value = $8,400

Total present value of cash flows from owning = $47,800 + $5,850 + $8,400 = $62,050

Therefore, NAL = present value of leasing cash flows - present value of owning cash flows = $45,619.58 + $3,060.94 - $62,050 = -$13,369.48

Now, we need to calculate the Year 4 cash flows. In Year 4, the lease payments will be completed, and the equipment will be sold.

Cash flow from leasing in Year 4 = $0

Tax savings on lease payments in Year 4 = 25% x $13,800 x 0.6 = $2,070

Cash flow from owning in Year 4 = $8,400 (from resale value) - $39,000/4 = $-2,400 (depreciation)

Tax savings on depreciation in Year 4 = 25% x $9,750 (i.e. $39,000/4 x 0.6) = $2,437.50

Total cash flow in Year 4 = $0 + $2,070 - $2,400 + $2,437.50 = $107.50

Therefore, the amount of Year 4 cash flows when computing the NAL is -$107.50, which is closest to option B (-$19,638).

A Lessor Will Charge $13,800 a Year for Four Years