Suppose Clorox can lease a new computer data processing system for $974,000 per year for five years. Alternatively, it can purchase the system for 4.23 million. Assume Clorox has a borrowing cost of 7.2% and a tax rate of 25%, and the system will be obsolete at the end of five years.

a. If Clorox will depreciate the computer equipment on a straight-line basis over the next five years, and if the lease qualifies as a true tax lease, is it better to lease or finance the purchase of the equipment?

b. Suppose that if Clorox buys the equipment, it will use accelerated depreciation for tax purposes. Specifically, suppose it can expense 20% of the purchase price immediately and can take depreciation deductions equal to 32%, 19.2%, 11.52% and 5.76% of the purchase price over the next five years. Compare leasing with purchase in this case.

a. If Clorox will depreciate the computer equipment on a straight-line basis over the next five years, and if the lease qualifies as a true tax lease, is it better to lease or finance the purchase of the equipment?

If Clorox buys the equipment, it will pay $4.23 million upfront and have depreciation expenses of $_________per year, generating a depreciation tax shield of $________ year for years 1-5.(Round to the nearest dollar.)

it leases, the after-tax lease payments are $______________ (Round to the nearest dollar.)

If it leases, the FCF of leasing versus buying is $_______in year 0, __________in years 1-4, and $ ______year 5.(Round to the nearest dollar.)

The NPV of Lease - Buy is $___________. (Round to the nearest dollar.)

(Select from the drop-down menus.) Under these assumptions, the buy option is more attractive than the lease buy option.

b. Suppose that if Clorox buys the equipment, it will use accelerated depreciation for tax purposes. Specifically, suppose it can expense 20% of the purchase price immediately and can take depreciation deductions equal to 32%, 19.2%, 11.52%, 11.52% and 5.76% of the purchase price over the next five years. Compare leasing with purchase in this case.

For each year, complete the table below:

Year 0

Buy: Capital Expenditures $ _________

Depreciation Tax Shield $ __________

Free Cash Flow (Buy) $ __________

Lease:

Lease Payments $ _________

Income Tax Savings $__________

Free Cash Flow (Lease) $ __________

Lease vs. Buy:

Lease - Buy $ ____________

Year 1

Buy: Capital Expenditures $ _________

Depreciation Tax Shield $ __________

Free Cash Flow (Buy) $ __________

Lease:

Lease Payments $ _________

Income Tax Savings $__________

Free Cash Flow (Lease) $ __________

Lease vs. Buy:

Lease - Buy $ ____________

Year 2

Buy: Capital Expenditures $ _________

Depreciation Tax Shield $ __________

Free Cash Flow (Buy) $ __________

Lease:

Lease Payments $ _________

Income Tax Savings $__________

Free Cash Flow (Lease) $ __________

Lease vs. Buy:

Lease - Buy $ ____________

Year 3

Buy: Capital Expenditures $ _________

Depreciation Tax Shield $ __________

Free Cash Flow (Buy) $ __________

Lease:

Lease Payments $ _________

Income Tax Savings $__________

Free Cash Flow (Lease) $ __________

Lease vs. Buy:

Lease - Buy $ ____________

Year 4

Buy: Capital Expenditures $ _________

Depreciation Tax Shield $ __________

Free Cash Flow (Buy) $ __________

Lease:

Lease Payments $ _________

Income Tax Savings $__________

Free Cash Flow (Lease) $ __________

Lease vs. Buy:

Lease - Buy $ ____________

Year 5

Buy: Capital Expenditures $ _________

Depreciation Tax Shield $ __________

Free Cash Flow (Buy) $ __________

Lease:

Lease Payments $ _________

Income Tax Savings $__________

Free Cash Flow (Lease) $ __________

Lease vs. Buy:

Lease - Buy $ ____________

Under these assumptions, the buy lease option is more attractive than the lease buy option.