Ross5eChap22sm - 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 36% 0 1,264,310* 189646.5 1,074,664 68272.74 1 1,074,664 322,399 752,264 116063.66 2 752,264 225,679 526,585 81244.561 3 526,585 157,976 368,610 56871.192 4 368,610 132699.45 * 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 = 8%( 1– 0.36) = 5.12% PV(COBB)=1,264,310–[68,272.74+116,063.66/(1.0512) 1 +81,244.561/(1.0512) 2 +56,871.192/(1.0512) 3 Answers to End–of–Chapter Problems B– 71
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+132,699.45/(1.0512) 4 ] = $854,469.63 (Beginning of year Annuity) PV(COL)=376,100(1–0.36) 4 0512 . 0 A (1.0512)= $894,729.55 NPV=PV(COBB)–PV(COL)= $854,469.63 – $894,729.55= – $40,259.92 Since NPV is negative, you should not lease. 22.3 Cash flows from leasing to lessor Year 0 1 2 3 4 Investment ($1,264,310) Lease Revenue 376,100 376,100 376,100 376,100 Tax (41%) 154,201 154,201 154,201 154,201 CCA tax shield 68,273 116,064 81,245 56,871 132,699 Cash Flow ($974,138) $337,963 $303,144 $278,770 $132,699 Note: NPV = –974,138 + 337,963 /(1.0472)+ 303,144 /(1.0472 2 )+ 278,770 /(1.0472 3 )+ 132,699 /(1.0472 4 ) = –21,882.05 22.4 We would have to set NPV = 0 and solve for L, the lease payment. NPV = 0 = 854,469.69– L(1–0.36) 4 0512 . 0 A (1+0.0512) 854,469.69= L (0.64) (3.53608) (1.0512) $854,469.69== L 2.37896 L = $359,196.07 22.5 Cash flows without taxes Year 0 1 2 3 Investment $1,264,310 Lease payment –376,100 –376,100 –376,100 –376,100 Cash Flow $888,210 ($376,100) ($376,100) ($376,100) 22.6 Lease payment where the lessor breaks even: NPV = 0 = –1,264,310 + L (1–0.41) 4 0472 . 0 A (1+.0472) + 68,273+ 116,064 /(1.0472)+ 81,245 /(1.0472 2 ) + 56,817 /(1.0472 3 )+ 132,699 /(1.0472 4 ) L = $386,023 Answers to End–of–Chapter Problems B– 72
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Lease payment where the lessee breaks even: (Since the company pays no tax, it cannot benefit from the tax deduction of debt hence the cost of debt is the pretax cost 8%) Year 0 1 2 3 Investment $1,264,310 Lease payment –L –L –L –L Cash Flow $1,053,000 – L –L –L –L NPV = 0 = $1,264,310 – L 4 08 . 0 A (1+.08) L= $552,259.10 The lease will be profitable for both parties for lease payments between $386,023 and $552,259.10.
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This note was uploaded on 07/18/2010 for the course ECONMICS ECM359 taught by Professor Matazi during the Summer '10 term at University of Toronto.

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Ross5eChap22sm - Chapter 22: Leasing 22.1 a. b. Leasing can...

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