chprobSM_ch22

chprobSM_ch22 - Chapter 22 Leasing 22.1 a b Leasing can...

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Chapter 22: Leasing 22.1 a. Leasing can reduce uncertainty regarding the resale value of the asset that is leased. b. Leasing does not provide 100% financing although it may look as though it does. Since firms must try to maintain their optimal debt ratio, the use of lease simply displaces debt. Thus, leasing does not provide 100% financing. c. Although it is true that leasing displaces debt, empirical studies show that the companies that do a large amount of leasing also have a high debt-to-equity ratios. d. If the tax advantages of leasing were eliminated, leasing would probably disappear. The main reason for the existence of long-term leasing is the differential in the tax rates paid by the lessee and the lessor. e. Ownership, and not leasing, provides a better incentive to maintain an asset than does leasing. f. It may instead be that the manufacturers will give a cheaper price to lessees than to purchasers, due to price discrimination opportunities. 22.2 Let COBB = cost of borrowing and buying COL = cost of leasing Here we have assumed that this is the only asset in this CCA asset pool and that the asset pool is terminated at the end of the project. Tax Shield on CCA Year UCC - Opening $ CCA $ UCC- Closing $ Tax Shield at 40% $ 0 1,053,000 157,950* 895,050 63,180 1 895,050 268,515 626,535 107,406 2 626,535 187,961 438,574 75,184 3 438,574 131,572 307,002 52,629 4 307,002 122,801 * in the first years, only one half of the CCA can be claimed, so 15% has been used on the initial investment cost. Assuming the asset pool is terminated upon the end of the project, and that a terminal loss is claimed for the remaining asset value in the pool, in year 4 UCC 4 x Tc is the tax shield. After tax cost of borrowing = 7% ( 1- 0.40) = 4.2% PV(COBB)= =1,053,000-[63,180+107,406/(1.042) 1 +75,184/(1.042) 2 +52,629/(1.042) 3 +122,801/(1.042) 4 ] =1,053,000-[63,180+103,077+69,245+46,518+104,167] = 666,813 (Beginning of year Annuity) PV(COL)=315,000(1-0.4) 4 0.042 A (1.042)= $711,508 Answers to End-of-Chapter Problems B-71
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Or: PV(COL) = 189,000 + 189,000 3 0.042 A = 189,000+522,508=711,508 NPV=PV(COBB)-PV(COL)=666,813-711,508= -$44,695 Since NPV is negative, you should not lease. 22.3 Cash flows from leasing to lessor Year 0 1 2 3 4 Investment - $1,053,000 Lease payment 315,000 315,000 315,000 315,000 Payment shield - 126,000 - 126,000 - 126,000 - 126,000 Forgone tax shield on CCA 63,180 107,406 75,184 52,629 122,801 -$800,820 296,406 264,184 241,629 122,801 NOTE: NPV= -800,820 +296,406/(1.042)+ 264,184/(1.042 2 )+ 241,629/(1.042 3 )+ 122,801/ (1.042 4 ) = -800,820 + 284,459+243,316+213,573+104,167 = 44,695 22.4 We would have to set NPV = 0 and solve for L, the lease payment. NPV = 0 = 666,813– L(1-.40) 4 0.042 Α (1+0.042) 666,813 = L (0.60) (3.6129) (1.042) 2.25879 L = $666,813 L = $295,208 22.5 Cash flows without taxes Year 0 1 2 3 Investment $ 1,053,000 Lease payment -315,000 -315,000 -315,000 -315,000 Cash Flow $738,000 -$315,000 -$315,000 -$315,000 22.6 Lease payment where the lessor breaks even:
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chprobSM_ch22 - Chapter 22 Leasing 22.1 a b Leasing can...

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