Step 3 calculate the present value of the cash

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: le to maintenance, depreciation, and interest. Step 3 Calculate the present value of the cash outflows associated with the lease (from Step 1) and purchase (from Step 2) alternatives using the after-tax cost of debt as the discount rate. The after-tax cost of debt is used to evaluate the lease-versus-purchase decision because the decision itself involves the choice between two financing techniques—leasing and borrowing—that have very low risk. Step 4 Choose the alternative with the lower present value of cash outflows from Step 3. This will be the least-cost financing alternative. The application of each of these steps is demonstrated in the following example. EXAMPLE Roberts Company, a small machine shop, is contemplating acquiring a new machine that costs $24,000. Arrangements can be made to lease or purchase the machine. The firm is in the 40% tax bracket. Lease The firm would obtain a 5-year lease requiring annual end-of-year lease payments of $6,000.2 All maintenance costs would be paid by the lessor, and insu...
View Full Document

Ask a homework question - tutors are online