--%>
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 : Cost of capital 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

    		•
  • Q : WCR fend off takeover bid WCR fend off

    WCR fend off takeover bid: The WCR estimation ensures that a firm takes corrective action in time to correct its WC status. This ensures that the firm is always in a positive WC status. In other words, the firm will be able to pay off all its short-te

    		•
  • Q : Finance A middle income worker, with a

    A middle income worker, with a dependent spouse older than the normal retirement age, retired in January 2004. In the year prior to retirement, her gross monthly earnings were $1,500. Her Social Security pension benefit is $1,000 per month. Prior to retirement, she was subject to total taxes on her

    		•
  • Q : Vanilla Bonds-Corporate Bonds Define

    Define the term Vanilla Bonds regarding Corporate Bonds?

    		•
  • Q : Efficiency Ratios Efficiency Ratios :

    Efficiency Ratios: These ratios comprise Receivables Turnover, Inventory Turnover, Asset Turnover and Net Working Capital Turnover ratios. Efficiency ratios show the utilization of Assets of the company thus as to generate Revenue that is, the best ut

    		•
  • Q : Explain the structure

    Our company (A) is going to buy the other company (B). We need to value the shares of B and, thus, we will use three options of the structure Debt/Shareholders’ Equity in order to obtain the WACC as: 1) Present structure of A

    		•
  • Q : Is Capital Cash Flow identical with

    Is Capital Cash Flow identical with Free Cash Flow?

    		•
  • Q : Bank assignment You have just been

    You have just been hired as the branch manager for a big bank in XYZ. You were told that the bank is going to open a new branch at Island Learning Centre of the Open University of XYZ. The management of the bank is much concerned that the new branch might not be able

    		•
  • Q : How could we acquire an indisputable

    How could we acquire an indisputable discount rate?

    		•
  • Q : Explain the working of breakthrough for

    Explain the working of breakthrough in low-discrepancy sequences used for option valuation.

    		•