Unformatted text preview: purchasing alternative is given in column 6.
Step 4 Because the present value of cash outflows for leasing ($18,151) is lower
than that for purchasing ($19,539), the leasing alternative is preferred.
Leasing results in an incremental savings of $1,388 ($19,539 $18,151)
and is therefore the less costly alternative.8 6. Although other cash outflows such as insurance and operating expenses may be relevant here, they would be the
same under the lease and purchase alternatives and therefore would cancel out in the final analysis.
7. If we ignore any flotation costs, the firm’s after-tax cost of debt would be 5.4% [9% debt cost (1 0.40 tax
rate)]. To reflect both the flotation costs associated with selling new debt and the possible need to sell the debt at a
discount, we use an after-tax debt cost of 6% as the applicable discount rate. A more detailed discussion of techniques for calculating the after-tax cost of debt is found in Chapter 11.
8. Using a financial calculator would reveal the present value of the cash outflows for the lease to be $18,154, and
that for the purchase to be $19,541, resulting in an incremental savings of $1,387. 680 PART 6 TABLE 16.3 Specia...
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