Calculate the present value to XYZ Ltd of cash flows from the ownership of equipment that it intends to lease to another company for five years.The equipment costs $500 000 and can be depreciated straight-line over three years for tax purposes.Assume the cost of capital is 10% p.a. ,the residual value is 20 per cent of cost and the tax rate is 30 per cent.

Question

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The present value of the cash flows from the equipment can be calculated by considering the depreciation tax shield, the after-tax cash flow from the lease, and the after-tax residual value. The depreciation expense is $500,000 / 3 = $166,667 per year for three years. The tax shield from depreciation is $166,667 * 30% = $50,000 per year for three years. The after-tax residual value is 20% of $500,000 = $100,000, and after-tax, it is $100,000 * (1 - 30%) = $70,000. The present value of these cash flows, discounted at 10%, plus the present value of the lease payments (not specified but are part of the cash flows), will give the total present value. Without the specific lease payment amounts, we focus on the methodology, which involves discounting these known values back at the cost of capital to find the present value. The correct answer, based on the information provided and typical lease valuation methods, would be an estimation since the actual lease payments are not specified. However, given the choices, the closest to a reasonable estimate with the given parameters is option B, assuming it accounts for the present value of all specified cash flows correctly.

Calculate the Present Value to XYZ Ltd of Cash Flows