Answer:
$4,200
Explanation:
Cost of equipment = $52,000
Life of equipment = 3 years
Depreciation through straight line method = 52,000/3 = $17,333
Tax rate = 33%
Pretax cost of debt = 10%
Lease amount of equipment = $18,500
After tax cost of debt = 10%*(1-0.33)
After tax cost of debt = 10%*(0.67)
After tax cost of debt = 0.067
After tax cost of debt = 6.7%
After tax lease payment amount = 18,500*(1-0.33)
After tax lease payment amount = 18,500*0.67
After tax lease payment amount = 12,395
Present Value of 3 lease payment = 12,395/(1+0.067) + 12,395/(1+0.067)^2 + 12,395/(1+0.067)^3
Present Value of 3 lease payment = 12395/1.067 + 12395/1.1385 + 12395/1.2148
Present Value of 3 lease payment = 11616.68 + 10887.13 + 10203.33
Present Value of 3 lease payment = $32,707.14
Present Value of cost involved in purchasing the equipment is $52,000, however there will be a tax shield from depreciation therefore, this amount would reduce the company's cost.
Annual depreciation tax shield = 17,333*0.33 = $5719.89. There will be tax shield on depreciation for 3 years. Therefore, present value of $5719.89 is calculated for three years:
= $5719.89/(1+0.067) + $5719.89/(1+0.067)^2 + $5719.89/(1+0.067)^3
= $5719.89/1.067 + $5719.89/1.1385 + $5719.89/1.2148
= $5360.72 + $5024.06 + $4708.50
= $15,093.28
Present Value of the cost of buying the equipment = $52,000 - $15,093.28 = $36,906.72
Net Advantage Leasing = Present Value of the cost of buying the equipment - Present Value of 3 lease payment
Net Advantage Leasing = $36,906.72 - $32,707.14
Net Advantage Leasing = $4,199.58
Net Advantage Leasing = $4,200.
