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Lecture

Leasing problems 22.2-22.7.doc


Department
Sociology
Course Code
SOC 202
Professor
Louis Pike

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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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