The Button Company is considering the purchase of a new machine for $30,000 that has a life of 5 years and would be depreciated on a straightline basis to a zero salvage value over its life.The machine is expected to save the firm $12,500 per year in operating costs.There is no actual salvage value.Alternatively,the firm can lease the machine for $7,300 annually for 5 years,with the first payment due at the end of the first year.The firm's tax rate is 21 percent and its cost of debt is 10 percent.What is the net advantage to leasing for the lessee?

Question

Quizplus · Accepted Answer

First, let's calculate the after-tax cash flows for purchasing the machine:
Annual savings: $12,500
Depreciation expense: $6,000 ($30,000 / 5 years)
Taxable income: $6,500 ($12,500 - $6,000)
Tax savings: $1,365 (21% of $6,500)
After-tax cash flow: $13,135 ($12,500 + $1,365)

Now let's calculate the after-tax cash flows for leasing the machine:
Lease payment: $7,300
Tax savings: $1,533 (21% of $7,300)
After-tax cash flow: $5,767 ($7,300 - $1,533)

The net advantage to leasing is the difference between the after-tax cash flows of leasing and purchasing. In this case, it is:
$5,767 x 5 - $30,000 = $1,869.12

Therefore, the best choice is to lease the machine.

The Button Company Is Considering the Purchase of a New