AAA Leasing is considering a lease to GHP Corp. of some new equipment. It would
ID: 2717045 • Letter: A
Question
AAA Leasing is considering a lease to GHP Corp. of some new equipment. It would be a 4 year contract with a $95,000 a year lease payment. Payments would be made at the end of the year and would include maintenance. If AAA Leasing enters into the lease agreement, they will have to buy the equipment for $250,000 and pay the seller $7000 at the end of each year for maintenance service. This equipment falls into the MACRS 3 year class and it has a resale value of $25,000. AAA Leasing has a 40% tax rate and they require an 11% after tax return on equipment leases, which is also its WACC. In this example, the NAL is the NPV of the lease.
1. Should AAA Leasing write the lease? Why or why not?
Below is my solution to this problem, can you look at it and tell me if the Net Advantage to Leasing is correct?
Explanation / Answer
PV OF CASH FLOWS ARE NOT CORRECT
CORRECT PV OF CASH FLOWS
YEAR $
0 (2,50,000)
1 77,594.59
2 78,930.28
3 49,435.85
4 39,662.19
(4,377.09)
NET ADVANTAGE TO LEASING=$(4,377.09)+PV OF AFTER TAX SALVAGE
=$(4,377.09)+$9,880.96
=$5,503.87