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?

QUESTION 1

What is the after-tax discount rate?

		10%
		8.5%
		15%
		3%
		None of the above

10 points

QUESTION 2

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

		$0
		$15,310
		$5,525
		$2,000
		None of the above

10 points

QUESTION 3

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

		$0
		$15,310
		$5,525
		$2,000
		None of the above

10 points

QUESTION 4

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

		$0
		$15,310
		$5,525
		$2,000
		None of the above

10 points

QUESTION 5

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

		$0
		$15,310
		$5,525
		$2,000
		None of the above

10 points

QUESTION 6

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

		$0
		$15,310
		$5,525
		$2,000
		None of the above

10 points

QUESTION 7

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

		$0
		$15,310
		$5,525
		$5,995
		None of the above

10 points

QUESTION 8

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

		$6,000
		$6,350
		$1,700
		$2,000
		None of the above

10 points

QUESTION 9

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

		$6,000
		$6,350
		$1,700
		$2,000
		None of the above

10 points

QUESTION 10

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

		$6,000
		$6,350
		$1,700
		$2,000
		None of the above

10 points

QUESTION 11

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

		$6,000
		$6,350
		$1,700
		$2,000
		None of the above

10 points

QUESTION 12

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

		$14,262
		$5,584
		$766
		$4,971
		None of the above

10 points

QUESTION 13

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

		$14,262
		$5,584
		$766
		$4,971
		None of the above

10 points

QUESTION 14

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

		$14,262
		$5,584
		$766
		$4,971
		None of the above

10 points

QUESTION 15

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

		$14,262
		$5,584
		$766
		$4,971
		None of the above

10 points

QUESTION 16

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

True

False