This

**preview**shows half of the first page. to view the full**3 pages of the document.**FIN401 – Solutions to Questions 2-7 in Chapter 22 (Editions 5

and 6)

Note: Assume that all cash flows other than initial cost occur at the end of a period, unless otherwise

stated.

Solutions to Questions 2-7 (Edition 6 )

Information: Initial Cost (IC) = $2.5M, Before Tax Lease Payment (BTLP) = $800K, Number of

years = N=4, Before tax discount rate = .075, Tax rate = .37, After tax Lease Payment (ATLPA)

= (800*(1-.37)) = $504K, After tax discount rate (ATDR) = (.075*(1-.37)) = .04725, CCA rate = .

30

2. Should you lease or buy? You need to calculate the NAL and make a decision based on that

information.

NAL = + IC – PV(ATLP) – PV(CCATB)

The PV(ATLP) is based on N=4, PMT=$504,000, and r=.04725, …PV(ATLP) = 1,798,635

PV(CCATB) = [(Cdt)(r+d)][(1+.5r)/(1+r)] = [($2.5M*.3*.37)/(.04725+.3)][(1+.5(.04725))/

(1.04725)]

= $781,108

NAL = $2.5M -$1,798,635 - $781,108 = -$79,743

The NAL is negative. The firm should buy.

3. What are the cash flows from the lessor’s point of view, given a 37% tax rate?

The cash flows are exactly the same, but reversed.

NAL = - IC + PV(ATLP) + PV(CCATB) = $79,743

4. What would the lease payment have to be for both the lessor and lessee to be indifferent to

the lease? This question is asking us to calculate the Break-even lease payment. In order to

answer this question, set the NAL = 0 (the point at which the lessee breaks even) and solve for

the before-tax lease payment that sets the NAL equal to zero.

NAL = + IC – PV(ATLP) – PV(CCATB)

0 = $2.5M – PV(ATLP) - $781,108

PV(ATLP) = $2.5M - $781,108 = $1,718,892

We need to derive the annual after-tax lease payments from the PV(ATLP).

So, given a PV(ATLP)=$1,718,892, r=.04725, and N= 4, the PMT will be $481,655

We have not yet quite solved the problem, because we were asked for the lease payment that

we will make to the lessor (which is the before-tax lease payment, not the ATLP).

If ATLP = BTLP(1-t), then BTLP = ATLP / (1-t) = $481,655 / (1-.37) = $764,532

5. What is the NAL if the lessee does not pay taxes?

NAL = + IC – PV(ATLP) – PV(CCATB)

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