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Unformatted text preview: the depreciation tax shield cash flow we calculated earlier, we find: Aftertax lease payment = $1,274,954.24 – 393,750 = $881,204.24 Since this is the aftertax lease payment, we can now calculate the breakeven pretax lease payment as: Breakeven lease payment = $881,204.24/(1 – .35) = $1,355,698.83 4. If the tax rate is zero, there is no depreciation tax shield foregone. Also, the aftertax lease payment is the same as the pretax payment, and the aftertax cost of debt is the same as the pretax cost. So: Cost of debt = .08 Annual cost of leasing = leasing payment = $1,350,000 The NAL to leasing with these assumptions is: NAL = $4,500,000 – $1,350,000(PVIFA8%,4) = $28,628.77 424 5. We already calculated the breakeven lease payment for the lessor in Problem 3. The assumptions about the lessor concerning the tax rate have not changed. So, the lessor breaks even with a payment of $1,355,698.83 For the lessee, we need to calculate the breakeven lease payment which results in a zero NAL. Using the assumptions in Problem 4, we find: NAL = 0 = $4,500,000 – PMT(PVIFA8%,4) PMT = $1,358,643.62 So, the range of lease payments that would satisfy both the lessee and the lessor are: Total payment range = $1,355,698.83 to $1,358,643.62 6. The appropriate depreciation percentages for a 3year MACRS class asset can be found in Chapter 6. The depreciation percentages are 0.333, 0.444, 0.148, and 0.074. The cash flows from leasing are: Year 1: ($4,500,000)(.333)(.35) + $877,500 = $1,401,975 Year 2: ($4,500,000)(.444)(.35) + $877,500 = $1,576,800 Year 3: ($4,500,000)(.148)(.35) + $877,500 = $1,110,600 Year 4: ($4,500,000)(.074)(.35) + $877,500 = $994,050 NAL = $4,500,000 – $1,401,975/1.052 – $1,576,800/1.0522 – $1,110,600/1.0523 – $994,050/1.0524 NAL = − $22,969.80 The machine should not be leased. However, notice that the NAL is higher because of the accelerated tax benefits due to depreciation. It is possible that the accelerated depreciation benefits could make the NAL positive when compared to straightline depreciation. 7. We will calculate cash flows from the depreciation tax shield first. The depreciation tax shield is: Depreciation tax shield = ($435,000/5)(.35) = $30,450 The aftertax cost of the lease payments will be: Aftertax lease payment = ($107,500)(1 – .35) = $69,875 So, the total cash flows from leasing are: OCF = $30,450 + 69,875 = $100,325 The aftertax cost of debt is: Aftertax debt cost = .09(1 – .35) = .0585 Using all of this information, we can calculate the NAL as: NAL = $435,000 – $85,730(PVIFA5.85%,5) = $10,664.52 The NAL is positive, so the company should lease. 425 8. a. Since the lessee has an effective tax rate of zero, there is no depreciation tax shield foregone. Also, the aftertax lease payment is the same as the pretax payment, and the aftertax cost of debt is the same as the pretax cost. To find the most the lessee would pay, we set the NAL equal to zero and solve for the payment, doing so, we find the most the lessee will pay is: NAL = 0 = $780,000 – PMT(PVIFA7%,5) PMT = $190,234.74 b. We will calculate cash flows from the depreciation tax shield first. The depreciation tax shield is: Depreciation tax shield = ($780,000/5)(.35) = $54,600 The aftertax cost of debt is: Aftertax debt cost = .07(1 – .35) = .0455 Using all of this information, we can calculate the minimum lease payment for the lessor as: NAL = 0 = $780,000 – PMT(1 – .35)(PVIFA4.55%,5) + $54,600(PVIFA4.55%,5) PMT = $189,730.94 c. A lease payment less than $189,730.94 will give the lessor a negative NAL. A payment higher than $190,234.74 will give the lessee a negative NAL. In either case, no deal will be struck. Therefore, these represent the lower and upper bounds of possible lease prices during negotiations. Intermediate 9. The pretax cost savings are not relevant to the lease versus buy decision, since the firm will definitely use the equipment and realize the savings regardless of the financing choice made. The depreciation tax shield is: Depreciation tax shield lost = ($7,000,000/5)(.34) = $476,000 And the aftertax lease payment is: Aftertax lease payment = $1,650,000(1 – .34) = $1,089,000 The aftertax cost of debt is: Aftertax debt cost = .09(1 – .34) = .0594 or 5.94% With these cash flows, the NAL is: NAL = $7,000,000 – 1,089,000 – $1,089,000(PVIFA5.94%,4) – $476,000(PVIFA5.94%,5) = $123,947.57 The equipment should be leased. 426 To find the maximum payment, we find where the NAL is equal to zero, and solve for the payment. Using X to represent the maximum payment: NAL = 0 = $7,000,000 – X(1.0594)(PVIFA5.94%,5) – $476,000(PVIFA5.94%,5) X = $1,116,729.56 So the maximum pretax lease payment is: Pretax lease payment = $1,116,729.56/(1 – .34) = $1,692,014.48 10. The aftertax residual value of the asset is an opportunity cost to the leasing decision, occurring at the end of the project life (year 5). Also, the residual value is not really a debtlike cash flow, since there is uncertainty associated with it at year 0. Nevertheless, although a higher...
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 Spring '10
 eshmalwi
 Finance, Corporate Finance

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