Question

Kaleidescope entertainment is considering buying a machine that costs $557,000. the machine will be depreciated over four years by the straight - line method and will be worthless at that time. the company can lease the machine with year end payments of $152, 000. the company can issue bonds at an interest rate of 8 percent. the corporate tax rate is 22 percent. what is the nal of the lease?

Answer 1

The net advantage of leasing is $42,240.

Step-by-step explanation:

Kaleidoscope Entertainment should calculate the net advantage of leasing by comparing the cost of leasing with the cost of purchasing the machine.

The machine's depreciation over four years is $557,000 / 4 = $139,250 per year under the straight-line method. The annual cost of leasing is $152,000.

To find the net advantage of leasing, subtract the tax shield on depreciation from the lease payment:

`\[ \text{Net Advantage of Leasing} = \text{Lease Payment} - \text{Tax Shield on Depreciation} \]`

The tax shield on depreciation is the depreciation amount multiplied by the tax rate:

`\[ \text{Tax Shield on Depreciation} = \text{Depreciation} * \text{Tax Rate} \]`

Substitute the values into the formulas:

`\[ \text{Tax Shield on Depreciation} = $139,250 * 0.22 = $30,635 \]`

`\[ \text{Net Advantage of Leasing} = $152,000 - $30,635 = $121,365 \]`

This positive net advantage indicates that leasing is financially favorable. In this scenario, leasing the machine is more advantageous than purchasing, considering the associated tax benefits.