--%>
Assignment Help - homework help

Tax credit for lease payments problem

ABC Inc. is planning to lease a computer for $3000 per annum, payable in advance, for a period of 4 years. The lease will cover maintenance costs. ABC CFO feels that if he buys the same computer he should be able to sell it at 15% of the purchase price after 4 years. Though, in case of purchase, the company must pay annual maintenance expenses of $500 at the end of each year. The pretax cost of debt of ABC is 10% and its income tax rate is 35%. If ABC buys the computer, it will depreciate it fully in four years. What is the maximum price that ABC should pay for this computer? Assume that ABC can take the tax credit for lease payments a year later.

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 I be the price of machine. The after-tax cost of borrowing is 10% (1 – 0.3) = 7%.

Depreciation tax shield lost = (I/4)*0.35 = 0.0875I
Payment shield = 3000*0.35 = $1050
NPV = 0
I – 3000 + (1550 – 0.0875I)*3.426 – (3000*2.648) – 0.0758I = 0

On solving, we get I = $9,024.59

Since it can be sold at 15% of the purchase price after 4 years, the maximum price that ABC should pay for this computer is 15% more of this purchase price, which is $10,378.3

   Related Questions in Corporate Finance

  • Q : What is optimal capital structure What

    What is optimal capital structure?

    		•
  • Q : Purchaing or leasing problem Crawford

    Crawford Corporation is planning to lease a machine for the next 4 years for an annual lease payment of $3,000 paid in advance, plus a non-refundable initial fee of $3,000. There is a 1-year delay for the tax benefits of leasing. Crawford may buy the machine, deprecia

    		•
  • Q : Which data is the most suitable for

    Which data is the most suitable for finding betas?

    		•
  • Q : Define capital goods Capital goods :

    Capital goods: Goods employed in producing other goods are termed as capital goods.

    		•
  • Q : State Exploitation of favorable market

    Exploitation of favorable market conditions: The firms after estimating WCR are in a position to clearly identify their status of excess current assets. After this realization they can use this knowledge to encash conditions arising in market even for

    		•
  • Q : How can optimal capital structure be

    How can optimal capital structure be calculated?

    		•
  • Q : Strategy of Bear Spread State when

    State when markets are anticipated to go down then what is the Strategy of Bear Spread?

    		•
  • Q : Selling or purchasing problem Atlas

    Atlas Realty Company is interested in buying a house and renting it out for $12,000 a year, collecting the rent in advance each year. This will depreciate the house over 25 years; however sell it after 15 years at twice its purchase price. The maintenance expenditures

    		•
  • Q : Types of Corporate Bonds What are the

    What are the various types of Corporate Bonds?

    		•
  • Q : Define Working capital requirement

    Working capital requirement: Is a financial term known as WCR, which is used to judge the operational liquidity of the business and it is a part of operational capital. A firm in spite of having a good profitability and assets may not have a good liqu

    		•