Adjusted present value of the lease relative to the

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Adjusted present value of the lease relative to the purchase Net present value of the lease relative to the purchase when purchase is financed by all equity Additional effects when purchase is financed with some debt All-Equity Value From an earlier chapter, we know that the all-equity value is simply the NPV of the cash flows discounted at the pretax interest rate. For the Xomox example, we know from Table 21.3 that this value is: $592.03 $10,000 $2,330 A 0.0757575 5 This calculation is identical to method 1 in the earlier box except that we are now dis- counting at the pretax interest rate. The calculation states that the lease is preferred over the purchase by $592.03 if the purchase is financed by all equity. Because debt financing generates a tax subsidy, it is not surprising that the lease alternative would be preferred by almost $600 over the purchase alternative if debt were not allowed. Additional Effects of Debt We learned earlier in the text that the interest tax shield in any year is the interest multiplied by the corporate tax rate. Taking the interest in each of the five years from Table 21.6, the present value of the interest tax shield is: $679.71 = 0.34 $764.22 _________ 1.0757575 + $625.91 ___________ (1.0757575) 2 + $480.69 ___________ (1.0757575) 3 + $328.21 ___________ (1.0757575) 4 + $168.11 ___________ (1.0757575) 5 Appendix 21A www.mhhe.com/rwj
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