The controller has asked you to consider three separate options that your firm has for getting a new software/computer system. The first option is to lease the system. The annual payment will be $15 million for the first year and it will grow at 5% a year. The lease contract is 5 years long. In this case, the lease expenses are operating and therefore would be tax-deductible. The second option is to buy the system for $38 million and depreciate it over 4 years, which is the expected life of the project. A third choice is to buy the system for $38 million and take it as an immediate expense. The system has an expected life of 4 years. If the tax rate is 40% and the cost of capital is 10%, estimate the equivalent annual costs of each option.

The controller has asked you to consider three separate options that your firm has for getting a new software/computer system. The first option is to lease the system. The annual payment will be $15 million for the first year and it will grow at 5% a year. The lease contract is 5 years long. In this case, the lease expenses are operating and therefore would be tax-deductible. The second option is to buy the system for $38 million and depreciate it over 4 years, which is the expected life of the project. A third choice is to buy the system for $38 million and take it as an immediate expense. The system has an expected life of 4 years. If the tax rate is 40% and the cost of capital is 10%, estimate the equivalent annual costs of each option.

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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