Craxton Engineering will either purchase or lease a new $751,000 fabricator. If? purchased, the fabricator will...

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Craxton Engineering will either purchase or lease a new $751,000fabricator. If? purchased, the fabricator will be depreciated on a?straight-line basis over seven years. Craxton can lease thefabricator for $129, 000 per year for seven years.? Craxton's taxrate is 35%.
?(Assume the fabricator has no residual value at the end of theseven?years.)
a. What are the free cash flow consequences of buying thefabricator if the lease is a true tax? lease?
b. What are the free cash flow consequences of leasing thefabricator if the lease is a true tax? lease?
c. What are the incremental free cash flows of leasing versus?buying?

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3.6 Ratings (256 Votes)


a	ALTERNATIVE 1-PURCHASE
	Free Cash Flow:
	Cost of Fabricator in year 0	($751,000)
	Depreciation Tax shield:
	Annual Depreciation=751000/7=	$107,286
	Annual Depreciation Tax Shield	$37,550	(107286*Tax Rate(35%))

	Year	0	1	2	3	4	5	6	7
	Free Cash Flow	($751,000)	$37,550	$37,550	$37,550	$37,550	$37,550	$37,550	$37,550

b	ALTERNATIVE 2-LEASE
	Before tax annual cash flow	($129,000)
	After Tax Annual Cash Flow=129000*(1-Tax Rate)	($83,850)

	Year	0	1	2	3	4	5	6	7
	Free Cash Flow	$0	-$83,850	-$83,850	-$83,850	-$83,850	-$83,850	-$83,850	-$83,850

c	Incremental Free Cash Flow	0	1	2	3	4	5	6	7
		($751,000)	$121,400	$121,400	$121,400	$121,400	$121,400	$121,400	$121,400

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Transcribed Image Text

Craxton Engineering will either purchase or lease a new $751,000fabricator. If? purchased, the fabricator will be depreciated on a?straight-line basis over seven years. Craxton can lease thefabricator for $129, 000 per year for seven years.? Craxton's taxrate is 35%.?(Assume the fabricator has no residual value at the end of theseven?years.)a. What are the free cash flow consequences of buying thefabricator if the lease is a true tax? lease?b. What are the free cash flow consequences of leasing thefabricator if the lease is a true tax? lease?c. What are the incremental free cash flows of leasing versus?buying?