SOLUTION TO FIN5FMA TOPIC 4 TUTORIAL WORK AND DISCUSSION PROBLEM

The solution to this question can be determined by calculating the net advantage of
leasing (NAL), based on:

 Opportunity cost of leasing

 Present value of tax benefits from leasing
 Present value of tax benefits from borrowing

Opportunity cost of leasing

Opportunity cost of leasing = [$60,000 + ($60,000)(6.8165)] - $500,000 = -$31,010

(note the discount rate is 8.5%*0.7=5.95%)

Present value (PV) of tax benefits from leasing

PV of tax benefits from leasing = ($60,000 × 0.30)(7.3776) = $132,796.80

Present value of tax benefits from borrowing

Present
Depreciation Interest value Present
Year Total
allowance payment discount value
factor
1 $50,000 $42,500 92500 0.9438 87305.33
2 $50,000 $39,635 89635 0.8908 79850.14
3 $50,000 $36,527 86527 0.8408 72752.64
4 $50,000 $33,154 83154 0.7936 65990.18
5 $50,000 $29,495 79495 0.7490 59543.59
6 $50,000 $25,525 75525 0.7070 53393.08
7 $50,000 $21,217 71217 0.6673 47520.06
8 $50,000 $16,543 66543 0.6298 41907.78
9 $50,000 $11,472 61472 0.5944 36540.01
10 $50,000 $5,972 55972 0.5610 31402.28
Total 576205.10

PV of tax benefits from borrowing = $576,205.10 × 0.30 = $172,861.53

Net advantage of leasing

NAL =( $132,796.80- $172,861.53) –( -$31,010) = -$9,054.73

Thus, as the NAL is negative, Hoffman Mining Limited should elect to buy the
Caterpillar loader truck rather than to lease it.