--%>
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 : How could we project exchange rates How

    How could we project exchange rates within order to be capable to forecast exchange differences?

    		•
  • Q : Sinking Fund problem Berks Corporation

    Berks Corporation is expecting to have EBIT next year of $12 million, with a standard deviation of $6 million. Berks have $30 million in bonds with coupon of 10%, selling at par, which are being retired at the rate of $2 million annually. Berks also have 100,000 share

    		•
  • Q : Explain definition of put–call parity

    Explain the definition of put–call parity described by Reinach.

    		•
  • Q : Porters Secondary activities Porter's

    Porter's Secondary activities: 1. Procurement: • Identification process of raw material.• Identification process of identifying probable suppliers.• Process of purchasing and calling quotes. 2. Human Resource management:

    		•
  • Q : What did better mean specified by

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

    		•
  • Q : Illustrates the Gordon and Shapiro

    What is the importance and the utility of the given formula: Ke = DIV(1+g)/P + g?

    		•
  • Q : Attributes of debt securities What are

    What are the Attributes of debt securities?

    		•
  • Q : 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.

    		•
  • Q : Problem on EBIT ABC Corporation stock

    ABC Corporation stock sells at $27 per share and its dividend per share is $1.20. ABC has price-earnings ratio of 16. The company contains $40 million worth of bonds, selling at par, with 8.5% coupon. The EBIT of ABC is of $12 million and its tax rate is 30%. Calculat

    		•
  • Q : Probability of dividend Universal

    Universal Corporation has the following dividend policy: if the earnings after taxes are less than $1 million, the dividend payout ratio will be 35%, but if these earnings are over $1 million, the dividend payout ratio will be 45%. The EBIT of Universal for next year

    		•