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Homework answers / question archive / metro is thinking of leasing a new materials
metro is thinking of leasing a new materials. The lease lasts for eight years. The lease calls for eight payments of 262,000 per year with the first payment taking place right away. materials would cost 1,800,000 to purchase and would be straight-line depreciated to a 0 salvage value over eight year. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 5 percent. The corporate tax rate is 25 percent. What is the NPV of the lease relative to the purchase?
Discount rate = post tax cost of debt = Rate at which firm can borrow x (1 - T) = 5% x (1 - 25%) = 3.75%
NPV of leasing costs = PV (Rate, Nper, PMT, FV, Type) = PV (3.75%, 8, 196500, 1) = -1,386,877.42
When we buy, initial cost = C0 = - 1,800,000
Depreciation tax shield (DTS) per annum = Annual depreciation x T = 1,800,000 / 8 x 25% = 56,250
PV of DTS = PV (Rate, Nper, PMT, FV) = PV (3.75%, 8, 56250, 0) = 382,657.25
Hence, NPV of buying = C0 + PV of DTS = - 1,800,000 + 382,657.25 = -1,417,342.75
Hence, net advantage of leasing = the NPV of the lease relative to the purchase = NPV of leasing costs - NPV of buying = -1,386,877.42 - ( -1,417,342.75) = $ 30,465.33
Hence, the correct answer is $ 30,465.33
