If a firm can borrow at 9 percent, what discount rate should the firm use to discount lease cash flows? (The marginal tax rate for the firm is 35 percent.)

Question

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Since the cash flows from the lease are expected to be received in the future, they need to be discounted back to the present using a discount rate. The appropriate discount rate to use is the firm's cost of borrowing, which is 9 percent. However, since the firm has a marginal tax rate of 35 percent, the after-tax cost of debt is (1-0.35) x 9% = 5.85%. Therefore, the firm should use a discount rate of 5.85% to discount the lease cash flows. Choice B is the only option that matches this calculation.

If a Firm Can Borrow at 9 Percent, What Discount