Suppose an asset has a purchase cost of $15,000, a life of five years, a salvage value of $3,000 at the end of five years, and a net annual before‐tax revenue of $7,500. The firm’s marginal tax rate is 35%. The asset will be depreciated by five‐year MACRS.
(a) Determine the cash flow after taxes, assuming that the purchase cost will be entirely financed by the equity funds.
(b) Rework part (a), assuming that the entire investment would be financed by a bank loan at an interest rate of 9%.
(c) Given a choice between paying the purchase cost up front from the firm’s equity and using the financing method of part (b), show calculations to justify which is the better choice at an interest rate of 9%.