Use the following information to answer the question(s) below.
Rearden Metal is considering the purchase of a new blast furnace costing a total of $5 million dollars. This furnace will qualify for accelerated depreciation: 20% can be expense immediately, followed by 32%, 19.2%, 11.52%, 11.52% and 5.76% over the next five years. However, because of Rearden's substantial tax loss carry forwards, Rearden estimates its marginal tax rate to be only 10% over the next five years. Since Rearden will get very little tax benefit from the depreciation expense, they consider leasing the furnace instead. Suppose that Rearden and the lessor face the same 8% borrowing rate, but the lessor has a 40% marginal tax rate. Assume that the furnace is worthless after five years, the lease term is five years, and a lease would qualify as a true tax lease.
-Assuming that Rearden's annual lease payments are $1.2 million, then use the direct method, the NPV of leasing is closest to:
A) ($165,000)
B) ($95,000)
C) $0
D) $95,000

Question

Quizplus · Accepted Answer

The NPV of leasing is calculated by comparing the after-tax cost of leasing with the after-tax cost of owning. Given Rearden's low tax rate, the tax benefits from depreciation are minimal, making leasing more attractive. The lessor's higher tax rate allows them to benefit more from depreciation, reducing the lease cost. Calculating the NPV using the direct method shows a negative value, indicating leasing is cheaper.

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