--%>

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 are Workpapers Workpapers : In

    Workpapers: In finance world, work papers are documents which are created during the procedure of computing the financial records of a business or individual. The accounting professional which is tasked with examining the book-keeping of a business mi

  • Q : Why do a Split Why do a Split?

    Why do a Split?

  • Q : Provide three examples of mutually

    provide three examples of mutually exclusive projects?

  • Q : Case Study 2 You have joined Zurich

    You have joined Zurich Pvt. Ltd as a Finance manager. You are given the following information: Zurich Pvt Ltd. is a diversified manufacturing firm dealing with electrical appliances. In 2012, the firm reported an operating income of Rs. 857.60 million and faced a tax rate of 35% on income. The firm

  • Q : Low-discrepancy sequence or quasi

    Who proposed definition and development of low-discrepancy sequence theory or quasi random number theory?

  • Q : Illustrates cost of its equity is zero

    Is this true that the cost of its equity is zero, if a company does not distribute dividends?

  • Q : Weighted return and simple return to

    What is the difference between weighted return and simple return to shareholders?

  • Q : Problem on rules of the International

    RainFlower Trading Limited is a wholesaler of electronic calculators in Hong Kong. It has been importing goods from a Philippine manufacturer for eight years. The Philippine manufacturer had accepted payments in advance in the past. Recently, because of political turm

  • Q : What are the different types of

    What are the different types of mathematics found in quantitative finance?

  • Q : Problem on Decision variables A factory

    A factory has three distinct systems for making similar product: System 1: Worker runs 3 machines of type-A, each of which costs $20 per day to run, each generates 100 units per day and the worker is paid $40 per day.System 2