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?

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

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

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

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

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

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

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

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

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

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

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

Answer rating: 100% (QA)

To determine whether to lease or purchase the widget we need to compare the costs and benefits of each option 1 Present value of lease payment The present value of the lease payment can be calculated ... View the full answer