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Problem on annual lease payments

Taurus Corporation needs a computer, which it can buy for $100,000. Taurus will depreciate the computer uniformly over its useful life of 5 years. An investment tax credit of 7% is also available, and the computer will have no residual value. Taurus plans to borrow the money at an interest rate of 10% specifically to finance the purchase. The tax rate of Taurus is 35%. Gemini Leasing Corporation can also lease the same computer to Taurus for the same period. Calculate the annual lease payments, made in advance each year, and their tax benefit taken right away, that will make Taurus indifferent to leasing or buying.

E

Expert

Verified

If the company has to be indifferent to leasing or buying, the net present value has to be set at zero. Let L be the annual lease payment. The after-tax cost of borrowing is 10% (1 – 0.35) = 6.5%.
Depreciation tax shield lost = (100000/5)*0.35 = $7000
Investment tax credit = 100000*7% = 7000/5 = $1400
Lost credit and shield = 7000 + 1400 = 8400
NPV = 0
100,000 – 0.65L – (0.65L*3.426) – (8400*4.156) = 0
2.8769L = 65089.6
L = $22,624.91

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