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Chapter 5: Q1P-a (page 542)

Howell Auto Parts is considering whether to borrow funds and purchase an asset or to lease the asset under an operating lease arrangement. If the company purchases the asset, the cost will be \(10,000. It can borrow funds for four years at 12 percent interest. The firm will use the three-year MACRS depreciation category (with the associated four-year write-off). Assume a tax rate of 35 percent.

The other alternative is to sign two operating leases, one with payments of \)2,600 for the first two years, and the other with payments of $4,600 for the last two years. In your analysis, round all values to the nearest dollar.

a. Compute the after-tax cost of the leases for the four years.

Short Answer

Expert verified

The after-tax cost of leases will be $1,690 in the first two years and $2,990 in the last two years.

Step by step solution

01

Information provided in question

Tax rate = 35%

Payment for first two years = $2,600

Payment for las two years = $4,600

02

Calculation of tax cost of leases

The after-tax cost of leases will be $1,690 in the first two years and $2,990 in the last two years.

Year

Payment

Tax shield

After-tax cost

1

$2,600

$910

$1,690

2

$2,600

$910

$1,690

3

$4,600

$1,610

$2,990

4

$4,600

$1,610

$2,990

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