Case:

Nodhead College needs a new supercomputer. It can either buy it for $250,000 or lease it from Compulease. The lease terms require Nodhead to make six annual payments of $62,000, all made at the start of the year. Nodhead pays no tax and will take care of maintenance whether it buys or leases.

Compulease pays tax at 35 per cent. Compulease depreciates the supercomputer for tax purposes over 5 years using the straight line method. The computer will have no residual value at the end of year 5.

The applicable discount rate is 8% p.a.

Questions:

1. Whywouldafirmleaseanassetwhenitcouldborrowtobuyanasset?Whataretheadvantagesoftheformerarrangementoverthelatter?
2. In the base case described above, compute the NPV of the lease from the viewpoint of the lessor and the viewpoint of the lessee. Would Nodhead enter into a lease arrangement? Would Compulease?
3. Variations to the lease are indicated below. Compute the NPV of the lease from the viewpoint of the lessor and the viewpoint of the lessee in each of the cases. Treat each variation independently; that is, use the information in the base case in all cases save for indicated change.

• Both entities are taxed at 35% (i.e., the environment of the lessor and lessee are identical)
• The applicable discount rate is 28%.
• Both entities are taxed at 35%. Also, Nodhead uses 19% as the discount rate and Compulease uses 18%