Your ﬁrm is considering leasing a new computer.The lease lasts for 9 years.The lease calls for 10 payments of £1,000 per year with the ﬁrst payment occurring immediately.The computer would cost
£7,650 to buy and would be straight-line depreciated to a zero salvage over 9 years.The actual
Salvage value is negligible because of technological obsolescence.The ﬁrm can borrow at a rate of
8%)The corporate tax rate is 30%.
What is the after-tax cash ﬂow from leasing relative to the after-tax cash ﬂow from purchasing in years
1-9?
A)£-255
B)£-955
C)£-1,295
D)£-1,850
E)None of the above.

Question

Quizplus · Accepted Answer

First, we need to calculate the after-tax cost of leasing and the after-tax cost of purchasing.

After-tax cost of leasing:
Yearly lease payment = £1,000
Lease term = 9 years
Total lease payments = £10,000

After-tax cost of lease payments:
£10,000 x (1-0.3) = £7,000

Total cost of leasing:
£7,000

After-tax cost of purchasing:
Purchase price = £7,650

Depreciation per year = £7,650/9 = £850

Tax depreciation shield = £850 x 0.3 = £255

After-tax cost of purchasing:
£7,650 - £255 = £7,395

Since the after-tax cost of purchasing is lower than the after-tax cost of leasing, it is better to purchase the computer rather than leasing it. Therefore, the answer is B because the after-tax cash flow from leasing is £955 worse off than the after-tax cash flow from purchasing in years 1-9.

Your ﬁRm Is Considering Leasing a New Computer