Angie Corporation is evaluating whether to lease or purchase equipment. Its tax rate is 30 percent. If...

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Angie Corporation is evaluating whether to lease or purchaseequipment. Its tax rate is 30 percent. If the companypurchases the equipment for $2,000,000 it will depreciate it over 4years, using straight-line depreciation. No salvage value isexpected. If the company enters into a 4-year lease, thelease payment is $600,000 per year, payable at the beginning ofeach year. If the company purchases the equipment it will borrowfrom its bank at an interest rate of 10 percent.
Calculate the cost of purchasing the equipment.

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4.5 Ratings (737 Votes)


Purchase

Interest rate	10%
Tax	30%
Effective rate	7.00%

Year	0	1	2	3	4
Depreciation		500000	500000	500000	500000
Tax shield		150000	150000	150000	150000
Interest payment		200000	200000	200000	200000
Tax shield		60000	60000	60000	60000
Total tax shield		210000	210000	210000	210000
Less: interest payment		200000	200000	200000	200000
Less: loan repayment					2000000
Net cash Flow		10000	10000	10000	-1990000

NPV @ 7%	($1,491,918.31)

So cost of purchase	$1,491,918.31

Lease
Year	0	1	2	3	4
Lease payment	600000	600000	600000	600000
Tax shield	180000	180000	180000	180000
Net cash out Flow	420000	420000	420000	420000	0

NPV @ 7%	($682,212.74)

So cost of lease	$682,212.74

Clearly leasing is cheaper

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Angie Corporation is evaluating whether to lease or purchaseequipment. Its tax rate is 30 percent. If the companypurchases the equipment for $2,000,000 it will depreciate it over 4years, using straight-line depreciation. No salvage value isexpected. If the company enters into a 4-year lease, thelease payment is $600,000 per year, payable at the beginning ofeach year. If the company purchases the equipment it will borrowfrom its bank at an interest rate of 10 percent. Calculate the cost of purchasing the equipment.