Carnival Company is considering leasing a new equipment. The lease lasts for 8 y
ID: 2656802 • Letter: C
Question
Carnival Company is considering leasing a new equipment. The lease lasts for 8 years. The lease calls for 8 payments of $9,000 per year with the first payment occurring immediately. The equipment would cost $60,000 to buy and would be straight-line depreciated to a zero salvage value over 8 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 6%. The corporate tax rate is 25%. What is the NPV of the lease relative to the purchase? $6,276.51 $4,729.61 -$3,519.26 -$2,537.00 -$1,556.47
Explanation / Answer
Answer : When they buy the equipment then ,
Assume that borrowed amount is paying as equally annual principal payments and installments are started from year 0.
Equal Principal amount will be : 60000/8 = 7500 p.a.
Here the P.V. Factor will be Interest(1-tax rate) = 6(1-0.25) = 4.5%
Depriciation on equipment = 60000/8 = 7500 p.a.
(1)
End of Year
(2)
Principal
(3)
Interest @ 6%
(4)
Principal Balance
(5)
Depriciation
(6)
Tax sheild [(3)+(5)]*25%
(7)
Cash Outflow [(2)+(3)]-(6)
(8)
P.V.Factors @ 4.5%
(9)
PV (7)*(8)
Hence , Net Cash outflow when company will buy the equipment 47635.21 $
When company will take equipment on lease
(1)
End of the year
(2)
Lease Payment
(3)
Tax sheild
(2)*25%
(4)
Cash outflow
(5)
PVIFA@4.5%
(6)
PV = (4)*(5)
Hence , Cash outflow on leasing an equipment will be 47196 $
Therefore , cash outflow in leasing is lower then buying , so , company should lease the equipment.
(1)
End of Year
(2)
Principal
(3)
Interest @ 6%
(4)
Principal Balance
(5)
Depriciation
(6)
Tax sheild [(3)+(5)]*25%
(7)
Cash Outflow [(2)+(3)]-(6)
(8)
P.V.Factors @ 4.5%
(9)
PV (7)*(8)
0 7500 0 52500 0 0 7500 1 7500 1 7500 3150 45000 7500 2662.5 7987.5 0.957 7644.04 2 7500 2700 37500 7500 2550 7650 0.916 7007.4 3 7500 2250 30000 7500 2437.5 7312.5 0.876 6405.75 4 7500 1800 22500 7500 2325 6975 0.839 5852.03 5 7500 1350 15000 7500 2212.5 6637.5 0.802 5323.28 6 7500 900 7500 7500 2100 6300 0.768 4838.4 7 7500 450 0 7500 1987.5 5962.5 0.735 4382.44 8 0 0 0 7500 1875 -1875 0.703 -1318.13 Total 47635.21