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Your company wants to purchase a new wax pouring machine for your candle-making business. The machine costs $240,000. It will be obsolete in three years

Your company wants to purchase a new wax pouring machine for your candle-making business. The machine costs $240,000. It will be obsolete in three years with zero salvage value. Your options are: To borrow & buy the machine, at an interest rate on debt of 10%, or; Lease the machine. If you lease, the lease payments are $90,000 per year, payable at the beginning of each year. If you buy the sequencer, you will use a CCA rate of 30%, calculated using the Accelerated Investment Incentive Method, and the asset pool will remain open after the machine becomes obsolete. The tax rate is 30%.

Time Period

0

1

2

3

Initial Cost

+$240,000

Lease Payments

Lease Tax Shield

CCA Tax Shield

Terminal Loss Tax Shield

Salvage Value

Annual Cash Flows

PV of Annual Cash Flows

Net Advantage to Leasing

What is the after-tax cost of debt that you should use for computing the PV of the lease?

A) 10%

B) 6%

C) 8%

D) 9%

E) 7%

If you buy the machine, what is the PV of the tax shield from CCA?

A) The PV of the tax shield from CCA is $60,288

B) The PV of the tax shield from CCA is $67,758

C) The PV of the tax shield from CCA is $56,469

D) None of the above are correct

What is the Net Advantage to Leasing (NAL) for the Lessee?

A) The NAL is -$2,153

B) The NAL is -$1,666

C) The NAL is +$245

D) The NAL is -$245

E) None of the above are correct

Based on your analysis above, what action should the company take?

A) The company is indifferent between leasing and buying.

B) They should buy the asset

C) They should lease the asset

In general, which of the following statements are correct with respect to leasing?

A) Leasing is most advantageous when the Lessee has a low tax rate and the Lessor has a high tax rate

B) Leasing is most advantageous when the Lessee has a high tax rate and the Lessor has a low tax rate

C) The true value of leasing arises due to the fact that leases do NOT have to appear on the Balance Sheet of the Lessee (if it is an Operating Lease)

D) All of the above are true

E) Only a) and c) are true

Now assume that your candle company has a zero percent (0%) marginal tax rate and you are trying to compute the maximum lease payment you would consider (referred to as a Reservation Payment in the PowerPoint). Which of the following is the correct maximum lease payment the company would consider, if it had a 0% marginal effective tax rate? You can use the following table to help organize your thoughts and the following formula to help you solve for the answer: Value of lease = $240,000 - Lmax(AnnuityDue Factor)

Time Period

0

1

2

3

Initial Cost

$240,000

Lease Payments

L Max

L Max

L Max

Lease Tax Shield

CCA Tax Shield

Terminal Loss Tax Shield

Salvage Value

Annual Cash Flows

PV of Annual Cash Flows

Net Advantage to Leasing

A) $85,470

B) $81,288

C) $87,734

D) $94,621

E) None of the above are correct

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