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A3. (Net advantage to leasing) A firm is considering leasing a computer system that costs $1,000,000 new. The lease requires annual payments of $135,000 in arrears for 10 years. The lessee pays income taxes at a 35% marginal rate. If it purchased the computer system, it could depreciate it to its expected residual value over 10 years. The lessee’s cost of similarly secured debt is 10% and its WACC is 15%. a. Calculate the net advantage to leasing assuming zero residual value. Should the firm lease the computer system? b. Calculate the net advantage to leasing assuming $250,000 residual value. Should the firm lease the computer system?

a.NAL = P - Σ [ (1 - T)(CFt - ΔEt) + TDt ] / [ 1 + (1 - T)r’ ]t - SAL / (1 + r)N - ITC
(1 - T)(CFt - ΔEt) + TDt = (1 - 0.35)($135,000 - $0) + 0.35 x ($1,000,000 - $0) / 10
(1 - T)(CFt - ΔEt) + TDt = $122,750
1 + (1 - T)r’ = 1 + (1 - 0.35) x 10% = 1.065
Σ $122,750 / 1.065 = n = 10 r = 6.5% PV = ? PMT = $122,750 FV = 0 PV = - $882,428.91SAL / (1 + r)N = $0 / 1.1510 = $0
NAL = $1,000,000 - $882,428.91- $0 = $117,571.09
The firm should lease.
b.NAL = P - Σ [ (1 - T)(CFt - ΔEt) + TDt ] / [ 1 + (1 - T)r’ ]t - SAL / (1 + r)N - ITC
(1 - T)(CFt - ΔEt) + TDt = (1 - 0.35)($135,000 - $0) + 0.35 x ($1,000,000 - $250,000) / 10
(1 - T)(CFt - ΔEt) + TDt = $114,000
1 + (1 - T)r’ = 1 + (1 - 0.35) x 10% = 1.065
Σ $114,000 / 1.065 = n = 10 r = 6.5% PV = ? PMT = $114,000 FV = 0 PV = -$819,526.65 SAL / (1 + r)N = $250,000 / 1.1510 = $61,796.18
NAL = $1,000,000 - $819,526.65 - $61,796.18 = $118,677.18
The firm should lease.
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