If Reynolds borrowed and bought, the bank would charge 10 percent interest on th
ID: 2772491 • Letter: I
Question
If Reynolds borrowed and bought, the bank would charge 10 percent interest on the loan. What is the NAL?
Reynolds Imaging needs a piece of diagnostic equipment that costs $200 thousand. Reynolds can either lease the equipment or borrow $200 thousand from a local bank and buy the equipment. Reynolds tax rate is 40 percent and the equipment depreciation would be $100 thousand per year. If the company leased the asset on a 2-year lease, the payment would be $110 thousand at the beginning of each year.If Reynolds borrowed and bought, the bank would charge 10 percent interest on the loan. What is the NAL?
Explanation / Answer
Solution:
Cost of capital (K) = 10%. cost of equipment = $200,000, tax rate = 40%
The company has two options: Borrowing and purchasing or Leasing.
NAL or Net Advantage on Leasing = Present value of Purchasing - Present value of Leasing
Case 1: Leasing
Case 2: Borrowing
Net present value of future payments is more in case of borrowing than in case of leasing.
Hence, NAL = 269,421.49-190,909.09 =
= $78,512.40
Ans: NAL = $78,512.40
Year (t) 1 2 Payment ($) 110,000 110,000 Discounting factor (1/(1+k)^t 0.909 0.826 Present value (Payment * DF) ($) 100,000.0 90,909.09 Net Present value 190,909.09