XYZ Ltd intends to lease to another company for a duration of five years equipment which 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,the tax rate is 30 per cent and that annual lease payments are payable in advance.Calculate the minimum after-tax lease payments if it desires a rate of return at 10 per cent after tax.

Question

Quizplus · Accepted Answer

The minimum after-tax lease payments is $77,476. This is calculated as follows:1. Calculate the annual depreciation expense: $500,000 / 3 = $166,6672. Calculate the annual tax savings from depreciation: $166,667 * 30% = $50,0003. Calculate the annual after-tax cash flow from depreciation: $166,667 - $50,000 = $116,6674. Calculate the present value of the annual after-tax cash flows from depreciation: $116,667 * (1 - (1 + 10%)^-5) / 10% = $426,6675. Calculate the residual value of the equipment: $500,000 * 20% = $100,0006. Calculate the present value of the residual value: $100,000 * (1 + 10%)^-5 = $62,0927. Calculate the minimum after-tax lease payments: $426,667 + $62,092 = $488,7598. Divide the minimum after-tax lease payments by 5 to get the annual after-tax lease payments: $488,759 / 5 = $77,476

XYZ Ltd Intends to Lease to Another Company for a Duration