(1)
Suppose Procter and Gamble (P&G) is considering
purchasing $10 million in new manufacturing equipment. If it purchases the
equipment, it will depreciate it on a straight-line basis over the five years,
after which the equipment will be worthless. It will also be responsible for
maintenance expenses of $1.75 million per year. Alternatively, it can lease the
equipment for$2.3 million per year for the five years, in which case the lessor
will provide necessary maintenance. Assume P&G?s tax rate is 30% and its borrowing
cost is 6.0%.
a. What is the NPV associated with leasing the equipment
versus financing it with the lease equivalent loan?
b. What is the break-even lease rate—that is, what lease
amount could P&G pay each year and be indifferent between leasing and
financing a purchase?
(2)
Suppose Amazon is considering the purchase of computer
servers and network infrastructure to expand its very successful business
offering cloud-based computing. In total, it will purchase $48.6 million in new
equipment. This equipment will qualify for accelerated depreciation: 20% can be
expensed immediately, followed by 32%, 19.2%, 11.52%, 11.52%, and 5.76% over
the next five years. However, because of the firm’s substantial loss
carryforwards and other credits, Amazon estimates its marginal tax rate to be
10% over the next five years, so it will get very little tax benefit from the
depreciation expenses. Thus, Amazon considers leasing the equipment instead.
Suppose Amazon and the lessor face the same 8.2% borrowing rate, but the lessor
has a 35% tax rate. For the purpose of this question, assume the equipment is
worthless after five years, the lease term is five years, and the lease
qualifies as a true tax lease.
a. What is the lease rate for which the lessor will break
even?
b. What is the gain to Amazon with this lease rate?
c. What is the source of the gain in this transaction?
ScholarMatic: Explanation & Answer
Your ready answer from a verified tutor is just a click away for as little as $14.99
Click Order Now to get 100% Original Answer Customized to your instructions!
