A manager has decided to buy a widget. Two alternative financing methods are available: (A) use a financial lease or (B) purchase the widget using owner financing and borrowed capital. The financial lease is a 3 year lease with annual lease payments of $6,500 paid at the beginning of each year (a lease payment is tax deductible; assume it can be claimed at the beginning of each year). The manager can buy the widget for $20,000 and sell it again in 3 years for $5,000. A bank will loan $15,000 and the loan will be fully amortized at 10% over 3 years with annual payments. The IRS will allow the widget to be depreciated over 10 years. The marginal tax rate is 15%. The manager requires at least a 10% pre-tax return on capital. Assume that the inflation rate is 0%. Should the manager buy or lease?

A.What is the after-tax discount rate?

a 10%

b 8,5%

c 15%

d 3%

B. What is the after-tax lease payment (absolute value)?

a $0

b $15,310

c $5,525

d $2,000

C. What is the annual depreciation if you lease the widget (absolute value)?

a $0

b $15,310

c $5,525

d $2,000

D. What is the tax savings from depreciation if you lease the widget (absolute value)?

a $0

b $15,310

c $5,525

d $2,000

E. What is the present value of the lease payment (absolute value)?

a $0

b $15,310

c $5,525

d $2,000

F. What is the net present value of leasing the widget (absolute value)?

a $0

b $15,310

c $5,525

d $2,000

G. What is the annuity equivalent of leasing the widet (absolute value)?

a. $0

b. $15,310

c. $5,525

d. $5,995

H. What is the after-tax terminal value if you purchase the widget (absolute value)?

a. $6,000

b. $6,350

c. $1,700

d. $2,000

I. What is the annual depreciation if you purchase the widget (absolute value)?

a. $6,000

b. $6,350

c. $1,700

d. $2,000

J. What is the accumulated depreciation over the first three years if you purchase the widget (absolute value)?

a. $6,000

b. $6,350

c. $1,700

d. $2,000

K. What is the annual tax savings from depreciation if you purchase the widget (absolute value)?

a. $1,700

b. $900

c. $300

d. $2,000

L. What is the present value of the after-tax terminal value if you purchase the widget (absolute value)?

a. $14,262

b. $5,584

c. $766

d. $4,971

M. What is the present value of the tax savings from depreciation if you purchase the widget (absolute value)?

a. $14,262

b. $5,584

c. $766

d. $4,971

N. What is the net present value of purchasing the widget (absolute value)?

a. $14,262

b. $5,584

c. $766

d. $4,971

O. What is the annuity equivalent of purchasing the widet (absolute value)?

a. $14,262

b. $5,584

c. $766

d. $4,971

P. Leasing the Widget has a lower cost so you would choose to lease the Widget?

a. True

b. False

IF THE ANSWER IS NOT IN THE OPTIONS A-D THEN JUST WRITE THE ANSWER OR SAY NONE OF THE ABOVE.