78106_18_Web_Ch18A_p01-02

78106_18_Web_Ch18A_p01-02 - WEB EXTENSION 18A Leasing...

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W E B E X T E N S I O N 18A Leasing Feedback W e have been assuming that the potential lessee has already made a firm deci- sion to acquire the new equipment. Thus, the lease analysis was conducted only to determine whether the equipment should be leased or purchased. However, if the cost of leasing is less than the cost of debt, it is possible for projects formerly deemed unacceptable to become acceptable. To illustrate this point, assume that (1) Anderson s target capital structure calls for 50% debt and 50% common equity; (2) Anderson s cost of debt, r d , is 10%; and (3) its cost of equity, r s , is 15%. Thus, Anderson s weighted average cost of capital is WACC ¼ 0 : 5 ð 10% Þð 0 : 65 Þ þ 0 : 5 ð 15% Þ ¼ 10 : 75% Further, assume that the firm s initial capital budgeting analysis on this equipment, using a 10.75% project cost of capital for average-risk projects, resulted in an NPV of - $50,000. As we show in Web Extension 18B , the after-tax cost of leasing for this project is 6.3%, compared with Anderson s after-tax cost of debt of 6.5%. Thus, this
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