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Essentials Of Investments
11th Edition
ISBN: 9781260013924
Author: Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher: Mcgraw-hill Education,
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JLB Corporation is attempting to determine whether to lease or purchase research equipment. The firm is in the 23% tax bracket, and its after-tax cost of debt is currently 9%. The terms of the lease and of the purchase are as follows:
Lease: Annual end-of-year lease payments of $30,000 are required over the three-year life of the lease. All maintenance costs will be paid by the lessor; insurance and other costs will be borne by the lessee. The lessee will exercise its option to purchase the asset for $6,500 at termination of the lease. Ignore any future tax benefit associated with the purchase of the equipment at the end of year 3 under the lease option.
Purchase: The equipment costs $70,000 and can be financed with a 15% loan requiring annual end-of-year payments of $30,658 for three years. JLB will depreciate the equipment under MACRS using a three-year recovery period. ((See TABLE below) for the applicable depreciation percentages.) JLB will pay $2,600 per year for a service contract that covers all maintenance costs; insurance and other costs will be borne by the firm. The firm plans to keep the equipment and use it beyond its three-year recovery period.
Rounded Depreciation Percentages by Recovery Year Using MACRS for First Four Property Classes
Rounded Depreciation Percentages by Recovery Year Using MACRS for First Four Property Classes | ||||
Percentage by recovery year Superscript a | ||||
Recovery year | 3 years | 5 years | 7 years | 10 years |
1 | 33% | 20% | 14% | 10% |
2 | 45% | 32% | 25% | 18% |
3 | 15% | 19% | 18% | 14% |
4 | 7% | 12% | 12% | 12% |
5 | 12% | 9% | 9% | |
6 | 5% | 9% | 8% | |
7 | 9% | 7% | ||
8 | 4% | 6% | ||
9 | 6% | |||
10 | 6% | |||
11 | 4% | |||
Totals | 100% | 100% | 100% | 100% |
a. Calculate the after-tax cash outflows associated with each alternative.
(Hint: Because insurance and other costs are borne by the firm under both alternatives, those costs can be ignored here.)
b. Calculate the present value of each stream, using the after-tax cost of debt.
c. Which alternative—lease or purchase—would you recommend? Why?
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Follow-up Questions
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Follow-up Question
Solution doesn't match.
a. The after-tax cash outflow associated with the lease in year 1 is
$23,100 (Round to the nearest dollar.)
The after-tax cash outflow associated with the lease in year 2 is
$23,100(Round to the nearest dollar.)
The after-tax cash outflow associated with the lease in year 3 is
$29,600 (Round to the nearest dollar.)
The after-tax cash outflow associated with the purchase in year 1 is
$24,932 (Round to the nearest dollar.)
The after-tax cash outflow associated with the purchase in year 2 is
$enter your response here. (Round to the nearest cent)
Solution
by Bartleby Expert
Follow-up Questions
Read through expert solutions to related follow-up questions below.
Follow-up Question
Solution doesn't match.
a. The after-tax cash outflow associated with the lease in year 1 is
$23,100 (Round to the nearest dollar.)
The after-tax cash outflow associated with the lease in year 2 is
$23,100(Round to the nearest dollar.)
The after-tax cash outflow associated with the lease in year 3 is
$29,600 (Round to the nearest dollar.)
The after-tax cash outflow associated with the purchase in year 1 is
$24,932 (Round to the nearest dollar.)
The after-tax cash outflow associated with the purchase in year 2 is
$enter your response here. (Round to the nearest cent)
Solution
by Bartleby Expert
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