NARRBEGIN: Bear Lake Lease Purchase
Bear Lake Equipment Company (BLEC)
Bear Lake Equipment Company (BLEC)is considering an expansion which will require a new machine that costs $125,000.BLEC can either lease or buy the equipment.The company's tax rate is 40% and its after tax cost of debt is 5%.
Lease: Annual payments of $26,400 made at the beginning of each year over five years.The lessor covers all maintenance,while the lessee covers insurance and other costs.The lessee has the option to purchase the machine for $31,250 paid along with the final lease payment.
Purchase: The $125,000 cost will be financed over five years with annual end of year payments of $31,580.The machine will be depreciated on the five year MACRS schedule,and the firm will pay $3,500 per year for a service contract to cover all maintenance.The company will cover all insurance and other costs.
-Refer to BLEC.What is the after-tax cash flow per year for the lease?

Question

Quizplus · Accepted Answer

To calculate the after-tax cash flow per year for the lease, we need to subtract the tax savings from the lease payment.

Payments per year = $26,400
Tax rate = 40%
After-tax cost of debt = 5%

Tax savings per year = Payments per year x Tax rate = $26,400 x 40% = $10,560

After-tax cash flow per year for the lease = Payments per year - Tax savings per year = $26,400 - $10,560 = $15,840

To determine the best choice, we need to compare the present value of cash flows for each option. We can use a financial calculator or spreadsheet to calculate the present value of each option based on the after-tax cash flows.

After calculating the present value of each option, if the present value of the lease is lower than the present value of the purchase, then the purchase would be the best choice. However, if the present value of the lease is higher, then the lease would be the best choice.

Without this information, we cannot determine the best choice.