--%>
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 repercussions do variations in

    What repercussions do variations in the oil price have on the value of a company?

    		•
  • Q : Explain value of shares is Is this

    Is this correct that the value of the shares is, the “value of the results’ capitalization” that, as per to the Institute of Accounting and Auditing (ICAC) shows “the sum of the expected future results of the company throughout a certain period

    		•
  • Q : Which method must use to valuate young

    Which method must we use to valuate young companies along with high growth but uncertain futures? Two illustrations were Boston Chicken and Telepizza while they began.

    		•
  • Q : Leverage ratio problem Handy Inc has

    Handy Inc has debt-to-assets ratio of 40%, tax rate of 35%, and total value of $100 million. W. C. Handy, the CFO, would like to increase the leverage ratio to 42%, and he believes that there will be no change in the bankruptcy cost of the company. How many dollars wo

    		•
  • Q : What is Regular supply of working

    Regular supply of working capital: The working capital requirement (WCR) estimation helps to ensure that the supply of raw material, which is essential to production, is uninterrupted. Therefore, the firm will be able to get sufficient credits and fun

    		•
  • Q : Explain investment of bank for

    When my company is not listed, therefore the investment banks apply an illiquidity premium. In fact, they say this is an illiquidity premium but then they call this a small cap premium. Only one of the banks, apparently based upon Tit

    		•
  • Q : Which taxes do I have to use for

    Which taxes do I have to utilize when calculating Free Cash Flow (FCF) – is this the medium tax rate or the marginal tax rate of the leveraged company?

    		•
  • Q : Marketing Decisions & Profitability

    Marketing Decisions Assignment:  Email the answers to the following questions in an attached word document using the proper file name format as follows:  1   

    		•
  • Q : What did better mean specified by

    What did ‘better’ mean specified with Markowitz questioned regarding portfolio selection?

    		•
  • Q : Which capital structure must consider

    Which capital structure must we consider when estimating the WACC for a subsidiary valuation: the one which is reasonable according to the risk of the subsidiary’s business that the average of the company or the one the subsidiary as “tolerates/per

    		•