Question
Q1. A firm is considering leasing some equipment for 5 years with equal annual lease payments. The equipment would cost $700,000 to buy and would
Q1. A firm is considering leasing some equipment for 5 years with equal annual lease payments. The equipment would cost $700,000 to buy and would be depreciated straightline over 5 years to a zero salvage value.The applicable pretax borrowing rate is 8 percent.The lessee's tax rate is 26 percent while the lessor's tax rate is 33 percent.Calculate the maximum lease payment that is acceptable to both parties.
Q2. An all-equity firm is pursuing a $2.9 million investment in a depreciable asset.The asset will be depreciated using the straight-line method over its 5 year life.The investment is expected to generate earnings before taxes and depreciation of $970,000 per year for five years.
The firm can obtain a five-year, non-amortizing loan at a rate of 10 percent to fully finance the project.The entire principal of the loan will be repaid in a balloon payment at the end of the fifth year while interest payments on the loan will be made at the end of each year.The firm's cost of unlevered equity is 12 percent and it faces a tax rate of 25 percent.Use the APV method to value the investment.
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