Task 6

Leasing: You are to use your critical thinking skills, collaboration techniques, creative problem-solving
tools and communication skills under the following scenario:

Your company (Acme Iron) is considering leasing a new computer, you and your team need to perform
analysis to support the decision-making process.  The lease lasts for 9 years.  The lease calls for 10
payments of $10,000 per year with the first payment occurring immediately.  The computer would cost
$70,650 to buy and would be straight-line depreciated to a zero salvage over 9 years.  The actual salvage
value is negligible because of technological obsolescence. The firm can borrow at a rate of 8%.  The
corporate tax rate is 30%. 

1. What is the after-tax cash flow from leasing relative to the after-tax cash flow from
purchasing in years 1-9? 
Years 0 1 2 3 4 5 6 7 8 9
After tax cash Flow from leasing (7,000) (7,000) (7,000) (7,000) (7,000) (7,000) (7,000) (7,000) (7,000) (7,000) (70,000)

Computer Cost Savings 70,650 70,650

Loss Depreciation Tax @ 30% (2,355) (2,355) (2,355) (2,355) (2,355) (2,355) (2,355) (2,355) (2,355) (21,195)
After tax cash Flow from leasing
relative to after tax flow from Purchasing 63,650 (9,355) (9,355) (9,355) (9,355) (9,355) (9,355) (9,355) (9,355) (9,355) (20,545)

2. What is the after-tax cash flow from leasing relative to the after-tax cash flow from
purchasing in year 0? 
Years 0
Annual Lease payments (10,000)
Less tax @30 % 3,000
After tax cash Flow from leasing (7,000)
Add Cost Price of the Computer 70,650
63,650

3. What is the NPV of the lease relative to the purchase? 

After-tax discount rate = (0.8*(1-0.3))
Year Cash Flows 0.56
0 63,650 1.0000 63,650
1 (9,355) 0.6410 (5,997)
2 (9,355) 0.4109 (3,844)
3 (9,355) 0.2634 (2,464)
4 (9,355) 0.1689 (1,580)
5 (9,355) 0.1082 (1,013)
6 (9,355) 0.0694 (649)
7 (9,355) 0.0445 (416)
8 (9,355) 0.0285 (267)
9 (9,355) 0.0183 (171)
Total NPV 47,250
47,250
 4. What would the after-tax cash flow in year 9 be if the asset had a residual value of $500
(ignoring any possible risk differences)? 
Year 9
Cash Flows in Year 9 2,338
After tax Salvage Value 500
After tax Cash Flow in year 9 2,838

5. Do you have a recommendation? 

Concept Check:  Understanding which cash flows are relevant is key to determining best financing
methods or project acceptance. It helps to detail all your assumptions within the model since questions
may arise years after the initial construction of the model. 

Helpful Hint: Creating a time-line with corresponding cash flows is usually helpful. You should also do
the NPV calculations showing your formula so if anyone wishes to change the variables they will know
how to proceed.