Dealing with Salvage value
Incorporating salvage into the NAL formula is fairly straightforward. If the asset will
have salvage value at the end of the lease, the lessee will obviously not get the salvage
value (the lessor will). So we need to subtract the (appropriately discounted) foregone
salvage value. We also need to remember that salvage changes the PVCCATS
calculation. Here is an example. The differences between an NAL problem with no
salvage and a problem with salvage are shown in red.
The Wildcat Oil Company needs to decide whether to buy or lease an asset. The asset
costs $6 million and has a 25% CCA rate. The equipment will have a $650,000 salvage
value at the end of its 5 year life. Wildcat’s tax rate is 36% and the pre-tax cost of debt is
8.5%. Leasing payments will be $1,350,000 per year. The lease payments are at the
beginning of each period, and the CCA pool remains open after the lease is completed.
Since the pool remains open, we can use the following formula:
NAL = I - PV of after-tax lease payments - PVCCAT