DogChew Products needs to replace its rawhide tanning and molding equipment. It can be used for ﬁve years and will have no salvage value. The equipment costs $930,000. The ﬁrm can lease it for
$245,000 a year, or it can borrow the money to purchase the equipment at 9%. The ﬁrm's tax rate is
39%) The CCA rate is 20% (Class 8).
Assuming straight-line depreciation to a salvage value of zero, what is the break-even lease
Payment?
A) $216,788
B) $225,621
C) $272,326
D) $293,037
E) $317,903

Question

Quizplus · Accepted Answer

To find the break-even lease payment, we need to calculate the after-tax cost of owning the equipment and compare it to the cost of leasing.

Cost of owning:
Depreciation per year = $930,000 x 20% = $186,000
Annual interest cost = $930,000 x 9% = $83,700
Total annual cost = $186,000 + $83,700 = $269,700
Tax savings = $269,700 x 39% = $105,363
After-tax cost of owning = $269,700 - $105,363 = $164,337

Lease cost = $245,000

At the break-even point, the after-tax cost of owning should be equal to the lease cost:

$164,337 = $245,000 - $105,363 x (1 - 39%)
$164,337 = $216,080.97
Therefore, the break-even lease payment is $225,621.

Comparing the cost of leasing to the after-tax cost of owning, it is more cost-effective to lease the equipment. Therefore, the best choice is to lease the equipment rather than buying it.

DogChew Products Needs to Replace Its Rawhide Tanning and Molding