Use the table for the question(s)below.
Your firm is contemplating leasing some new equipment.The cash flows of either buying or leasing the equipment are shown in the table above.
-If your firm's borrowing cost is 7% and the tax rate is 35%,what is the amount of the lease-equivalent loan for the new equipment?
A)$178,937
B)$169,070
C)$30,930
D)$21,063
E)-$14,145

Question

Use the table for the question(s)below.
  Your firm is contemplating leasing some new equipment.The cash flows of either buying or leasing the equipment are shown in the table above.
-If your firm's borrowing cost is 7% and the tax rate is 35%,what is the amount of the lease-equivalent loan for the new equipment?
A)$178,937 
B)$169,070 
C)$30,930 
D)$21,063 
E)-$14,145

Quizplus · Accepted Answer

The lease-equivalent loan is the present value of the lease payments, discounted at the after-tax borrowing cost. The after-tax borrowing cost is the borrowing cost minus the tax savings on the interest payments. The tax savings on the interest payments is the tax rate times the interest payments. The present value of the lease payments is the sum of the present values of each lease payment, discounted at the after-tax borrowing cost. The present value of each lease payment is the lease payment divided by the discount factor, which is 1 plus the after-tax borrowing cost raised to the power of the number of years until the payment is due.In this case, the borrowing cost is 7% and the tax rate is 35%. The after-tax borrowing cost is 7% - (35% * 7%) = 4.55%. The lease payments are $10,000 per year for 5 years. The present value of the lease payments is $10,000 / (1 + 4.55%)^1 + $10,000 / (1 + 4.55%)^2 + $10,000 / (1 + 4.55%)^3 + $10,000 / (1 + 4.55%)^4 + $10,000 / (1 + 4.55%)^5 = $45,527. The lease-equivalent loan is $45,527.

Use the Table for the Question(s)below