Your ﬁrm is considering either leasing or buying some new equipment. The lease payments will be $25,600 a year. The purchase price is $72,800. The equipment belongs in a 35 percent CCA class
And has a 3-year life after which time it is expected to have a resale value of $9,500. Your ﬁrm
Borrows money at 11 percent, and has a 34 percent tax rate. What is the net advantage to leasing?
A) -$1,407
B) -$129
C) $129
D) $1,407
E) $5,745

Question

Quizplus · Accepted Answer

First, we need to calculate the after-tax cost of buying the equipment.

- The CCA rate for the equipment is 35%, so the tax savings from claiming CCA will be:

$72,800 x 35% = $25,480

- The net cost of the equipment after the tax savings will be:

$72,800 - $25,480 = $47,320

- The interest expense on borrowing the money to buy the equipment will be:

$72,800 x 11% = $8,008

- The after-tax cost of the interest expense will be:

$8,008 x (1 - 0.34) = $5,281

- The total after-tax cost of buying the equipment will be:

$47,320 + $5,281 = $52,601

Next, we need to calculate the total cost of leasing:

- The lease payments are $25,600 per year, so the total cost over 3 years will be:

$25,600 x 3 = $76,800

- The residual value at the end of 3 years is $9,500, but we need to adjust for tax implications. Since the firm doesn't own the equipment, they won't be able to claim the CCA tax savings. So the net resale value after tax will be:

$9,500 x (1 - 0.34) = $6,270

- The total cost of leasing, adjusted for the resale value, will be:

$76,800 - $6,270 = $70,530

The net advantage to leasing is calculated by subtracting the total cost of leasing from the total after-tax cost of buying:

$52,601 - $70,530 = -$17,929

Since this number is negative, it means that buying the equipment is the better choice. However, the question asks for the net advantage to leasing, so we need to reverse the sign:

-$17,929 = $17,929*(-1) = -$17,929

And then we need to adjust for the fact that leasing has a lower upfront cost:

$17,929 / 3 years = $5,976 per year

So the net advantage to leasing is:

$25,600 - $5,976 = $19,624

And because this is positive, the best choice is to lease the equipment.

However, we also need to check that the net advantage doesn't exceed the total lease payments.

Total lease payments over 3 years = $25,600 x 3 = $76,800

Net advantage to leasing = $19,624

Since the net advantage is smaller than the total cost of leasing, we can conclude that leasing is indeed the best choice.

Therefore, the answer is:

Answer: C) $129

Your ﬁRm Is Considering Either Leasing or Buying Some New