Suppose Amazon is considering the purchase of computer servers and network infrastructure to expand its very successful business offering cloud-based computing. In total, it will purchase

$48 million in new equipment. This equipment will qualify for accelerated depreciation: 20%

can be expensed immediately, followed by 32%, 19.2%, 11.52%, 11.52%, and 5.76% over the next five years. However, because of the firm’s substantial loss carryforwards and other credits, Amazon estimates its marginal tax rate to be 5% over the next five years, so it will get very little tax benefit from the depreciation expenses. Thus, Amazon considers leasing the equipment instead. Suppose Amazon and the lessor face the same 8% borrowing rate, but the lessor has a 25% tax rate. For the purpose of this question, assume the equipment is worthless after five years, the lease term is five years, and the lease qualifies as a true tax lease.

a. What is the lease payment for which the lessor will break even?

b. What is the gain to Amazon with this lease rate?

c. What is the source of the gain in this transaction?

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