Marschall's is trying to decide whether to lease or buy some new equipment. The equipment costs $62,000 and has a 4-year life. The equipment will be worthless after the 4 years and will have to be
Replaced. The company has a tax rate of 35 percent, a cost of borrowed funds of 9 percent. The
Equipment can be leased for $16,500 a year. What is the amount of the after-tax lease payment?
A) $5,775
B) $8,350
C) $10,725
D) $11,690
E) $11,700

Question

Quizplus · Accepted Answer

First, let's calculate the after-tax cost of buying the equipment:

Year 0:
Initial cost: $62,000

Years 1-4:
Depreciation expense per year: $62,000/4 years = $15,500
Tax savings per year (assuming a tax rate of 35%): $15,500 x 35% = $5,425
After-tax cost per year (assuming a cost of borrowed funds of 9%): ($62,000 - $5,425) x 9% = $4,528

Year 4:
Salvage value: $0

Total after-tax cost of buying the equipment over 4 years: $62,000 + ($4,528 x 4) = $80,192

Now, let's calculate the after-tax cost of leasing the equipment:

After-tax lease payment: $16,500 x (1 - 35%) = $10,725

Total after-tax cost of leasing the equipment over 4 years: ($10,725 x 4) = $42,900

Comparing the two options, it's clear that leasing is the better choice as it has a total after-tax cost of $42,900 compared to the total after-tax cost of buying at $80,192. Therefore, the best choice is:

Answer: C

Marschall's Is Trying to Decide Whether to Lease or Buy