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 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 would the after-tax cash flow in year 9 be if the asset had a residual value of £500 (ignoring any possible risk differences)?

Question

Quizplus · Accepted Answer

First, we need to calculate the annual depreciation of the computer: 
£7,650 / 9 = £850 per year

Using this, we can calculate the pre-tax cash flows for each year:

Year 1: -£1,000 
Year 2-9: -£150 (lease payment - depreciation) 
Year 9: £350 (-£150 + £500 salvage value)

To calculate the after-tax cash flow in year 9, we need to take into account the tax shield from depreciation:

Tax shield = depreciation x tax rate 
Tax shield = £850 x 30% = £255

After-tax cash flow in year 9 = pre-tax cash flow in year 9 + tax shield 
After-tax cash flow in year 9 = £350 + £255 = £605

However, this is a negative number, indicating a net outflow of cash. Therefore, the correct answer is D.

Your Firm Is Considering Leasing a New Computer