0 1 2 3 4 5 6

Initial cost -75000

Maintenance cost -12000 -12000 -12000 -12000 -12000 -12000 -12000
35% tax shield on cost 4200 4200 4200 4200 4200 4200 4200
Tax shield on Dep. 5250 8400 5040 3018.75 3018.75 1522.5
Total -82800 -2550 600 -2760 -4781.25 -4781.25 -6277.5
Rate 7% 1 0.934579 0.873439 0.816298 0.762895 0.712986 0.666342
PV -82800 -2383.178 524.0632 -2252.982 -3647.593 -3408.965 -4182.963
NPV -98151.6177

PV

Annuity
PV -98151.6177
Rate 7%
Pmt $20,591.80
FV 0
Nper 6
Annual depeciation 0.166667 MACRS
SLM DBM 0.2 15000 5250
Cost 75000 75000 0.32 24000 8400
Life/Rate 6 0.166667 0.192 14400 5040
Annual dep 12500 12500 0.115 8625 3018.75
4375 0.115 8625 3018.75
0.058 4350 1522.5

0.07 0.112 0.0672

Lease V/S Buy
The Randolph Tewlves Company (RTC) has decided to acquire a new truck. One alternative is to lease the truck on a
4-year guidline contract for a lease payment of $10,000 per year, with payments to be made at the beginning of each
year. The lease would include maintenance. Alternatively, RTC could purchase the truck outright for $40,000,
financing the purchase by a bank loan for the net purchase price and amortizing the loan over a 4-year period at an
itnerest rate of 10 percent per year. Under the borrow to purchase arrangement, RTC would have to maintain the
truck at a cost of $1,000 per year, payable at year end. The truck fall into the MACRS 3-year class. it has a residual
value of $10,000, which is the expected market value after 4 years, when RTC plans to replace the truck irrespective
of whether it leases or buy. RTC has a marginal federal-plus-state tax rate of 40 percent.

a. What is the RTC's PV cost of leasing?

b. What is RTC's cost of owning? Should the truck be leased or purchased?

Rate Before tax Interest ra 10%

0.33 After tax interest rate = kd (1-t)
0.45 Tax rate = 40%
0.15 After tax interest rate = 0.1 (1-0.4)
0.07 After tax interest rate = 6%

Depreciation tax saving

Cost Rate Ann. Dep. Tax saving 40%
40000 0.33 13200 5280
40000 0.45 18000 7200
40000 0.15 6000 2400
40000 0.07 2800 1120
Acc. Dep. 40000 16000
Book value = cost - acc. Dep.
Book value = 0
Residual value = 10000
Gain on disposal 10000
tax @ 40% -4000
ATSV 6000

A B
EBITDA 100000 100000
less: Dep./Amortization 0 20000
EBIT 100000 80000
Less: Interest 0 0
EBT 100000 80000
Less: Tax @40% -40000 -32000

8000 tax saving

40%
 Cost of leasing
lease the truck on a Year 0 1 2 3
he beginning of each
for $40,000, Cash flow (10,000.00) (10,000.00) (10,000.00) (10,000.00)
4-year period at an Tax saving 40% 4,000.00 4,000.00 4,000.00 4,000.00
ve to maintain the Net cash flow (6,000.00) (6,000.00) (6,000.00) (6,000.00)
s. it has a residual
he truck irrespective Rate 6% 1.00 0.9434 0.8900 0.8396
PV ($6,000.00) ($5,660.38) ($5,339.98) ($5,037.72)
NPV of leasing ($22,038.07)

Cost of owning
Year 0 1 2 3
Net purchase price (40,000.00)
Main. Cost (1,000.00) (1,000.00) (1,000.00)
Tax saving @40% 400.00 400.00 400.00
Depreciation tax saving 5,280.00 7,200.00 2,400.00
Residual value
tax on residual value
Net cash flow (40,000) 4,680 6,600 1,800
Rate 6% 1.0000 0.9434 0.8900 0.8396
PV (40,000.00) 4,415.09 5,873.98 1,511.31
NPV of buying (23,035)

Conclusion:
The NPV of leasing is less than NPV of owning the asset. Therefore, the company should opt for lease thi
Cost of owning
Year 0 1 2
Purchase price (1,000,000)

Tax saving on expenses - -

Depreciation Expense (330,000) (450,000)
Tax saving on expenses 112,200 153,000
Net cash flow (1,000,000) 112,200 153,000
Discount rate 14% 1 0.8772 0.7695
PV (1,000,000) 98,421 117,729
NPV (749,427)

Cost of leasing
Year 0 1 2
Cash flow (320,000) (320,000)
Tax saving 108,800 108,800
Purchase at market value
Net cash flow (211,200) (211,200)
Discount rate 14% 0.8772 0.7695
PV (185,263) (162,512)
NPV (625,323)

The company should go for leasing instead of buying

Maintenance cost is expempted from the analysis because the company will have to bear the
 4
0

0
0.7921
$0.00

(1,000.00)
400.00
1,120.00
10,000.00
(4,000.00)
6,520
0.7921
5,164.45

ompany should opt for lease this asset instead of buying.

 3

-
(150,000) Depreciation expense
51,000 Year Cost Rate Exp
51,000 1 (1,000,000) 33% -330000
0.6750 2 (1,000,000) 45% -450000
34,424 3 (1,000,000) 15% -150000
4 (1,000,000) 7% -70000

3
(320,000)
108,800
(200,000)
 (411,200)
0.6750
(277,548)

e company will have to bear the cost of maintenance whether they buy or lease.
Lease V/S Buy
The Randolph Tewlves Company (RTC) has decided to acquire a new truck. One alternative is to lease the truck on a
4-year guidline contract for a lease payment of $10,000 per year, with payments to be made at the beginning of each
year. The lease would include maintenance. Alternatively, RTC could purchase the truck outright for $40,000,
financing the purchase by a bank loan for the net purchase price and amortizing the loan over a 4-year period at an
itnerest rate of 10 percent per year. Under the borrow to purchase arrangement, RTC would have to maintain the
truck at a cost of $1,000 per year, payable at year end. The truck fall into the MACRS 3-year class. it has a residual
value of $10,000, which is the expected market value after 4 years, when RTC plans to replace the truck irrespective
of whether it leases or buy. RTC has a marginal federal-plus-state tax rate of 40 percent.

a. What is the RTC's PV cost of leasing?

b. What is RTC's cost of owning? Should the truck be leased or purchased?

Annual Depreciation
Cost Rate D. Exp Tax saving
40000 0.33 13200 5280
40000 0.445 17800 7120
40000 0.148 5920 2368
40000 0.074 2960 1184
 Cost of leasing:
Year 0 1 2 3 4
lease the truck on a CF -10000 -10000 -10000 -10000 0
he beginning of each
for $40,000, Tax shield 40% 4000 4000 4000 4000
4-year period at an Net cash flow -6000 -6000 -6000 -6000
ve to maintain the Rate 6% 1.00 0.94 0.89 0.84
s. it has a residual
he truck irrespective PV ($6,000.00) ($5,660.38) ($5,339.98) ($5,037.72)
PV cost of lease ($22,038.07)

Cost of owning

Year 0 1 2 3 4
Net purchase price (40,000)
Maintenance cost (1,000) (1,000) (1,000)
(1,000)
Maintenance tax savings 400 400 400 400
Depreciation tax savings 5,280 7,120 2,3681,184
Residual value 10,000
Residual value tax (4,000)
Net cash flow (40,000) 4,680 6,520 1,768 6,584
Rate 6% 1 0.94339623 0.88999644 0.83961928 0.792093663
PV (40,000) 4,415 5,803 1,484 5,215
NPV (23,083)

Since the PV of the cost of leasing is less than the present value of the cost of the owning, the truck should be lease
, the truck should be leased. The net advantage of lease (NAL) is 23083-22038 = 997