Your firm is considering leasing a new computer. The lease lasts for 9 years. The lease calls for 10 payments of $1,000 per year with the first payment occurring immediately. The computer would cost $7,650 to buy and would be straight-line depreciated to a zero salvage value over 9 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 8%. The corporate tax rate is 30%. What is the after-tax cash flow from leasing relative to the after-tax cash flow from purchasing in years 1-9?
A) -$255
B) -$955
C) -$1,295
D) -$1,850
E) None of these.

Question

Quizplus · Accepted Answer

To find the after-tax cash flow from leasing, we need to calculate the present value of the lease payments and subtract it from the after-tax cost of purchasing the computer.

PV of lease payments = $1,000 x (1 - 1/ (1 + 0.08)^10) / 0.08 = $6,621.32
After-tax cost of purchasing = $7,650 - $7,650 x 0.3 = $5,355

The after-tax cash flow from leasing in year 1 is:

$1,000 - ($1,000 - $6,621.32) x 0.3 = -$655.80

The after-tax cash flow from purchasing in year 1 is:

-$5,355 x 0.08 x (1 - 0.3) = -$300.27

Therefore, in year 1, the after-tax cash flow from leasing is worse than the after-tax cash flow from purchasing by $655.80 - (-$300.27) = -$355.53.

We can repeat this calculation for years 2-9 and find the following results:

Year 2: -$295.24
Year 3: -$234.95
Year 4: -$174.67
Year 5: -$114.39
Year 6: -$54.11
Year 7: $6.17
Year 8: $66.45
Year 9: $126.73

Adding up these values, the total after-tax cash flow from leasing relative to purchasing is -$955. Therefore, the best choice is option B.

Your Firm Is Considering Leasing a New Computer