Question

A company is deciding whether to lease or buy new equipment. The equipment can be purchased for $60,000 or leased for a 6-year period for $11,500 per year (due at the beginning of each year). The firm can borrow at an after tax rate of 11%. If purchased, the company will incur insurance and maintenance costs of $500 per year. The equipment has a CCA rate of 21%. Salvage value in 6 years is expected to be $5,000. The company's marginal tax rate is 34%. Calculate the Net Advantage of Lease (NAL). Round the the Net Advantage of Lease to 2 decimals (e.g 22.05), and the unit is $.

Answer 1

The Net Advantage of Lease (NAL) is a financial appraisal technique used to compare the costs and benefits of leasing versus buying equipment.

Step-by-step explanation:

The Net Advantage of Lease (NAL) is a financial appraisal technique used to compare the costs and benefits of leasing versus buying equipment. For the purchase option, the initial cost of $60,000 should be discounted at the after-tax borrowing rate of 11% as well. Additionally, we need to consider the insurance and maintenance costs, and the salvage value. By comparing the present value of the costs and benefits for each option, we can determine which option, leasing or buying, has a higher net advantage.

Let's calculate the NAL:

1. Lease Option:
   • Present Value of Lease Payments: $11,500 / (1 + 0.11)^1 + $11,500 / (1 + 0.11)^2 + $11,500 / (1 + 0.11)^3 + $11,500 / (1 + 0.11)^4 + $11,500 / (1 + 0.11)^5 + $11,500 / (1 + 0.11)^6
2. Purchase Option:
   • Present Value of Initial Cost: $60,000 / (1 + 0.11)^1
   • Present Value of Insurance and Maintenance Costs: $500 / (1 + 0.11)^1 + $500 / (1 + 0.11)^2 + $500 / (1 + 0.11)^3 + $500 / (1 + 0.11)^4 + $500 / (1 + 0.11)^5 + $500 / (1 + 0.11)^6
   • Present Value of Salvage Value: $5,000 / (1 + 0.11)^6
3. Calculate the Net Advantage of Lease (NAL):
   • NAL = Present Value of Lease Payments - (Present Value of Initial Cost + Present Value of Insurance and Maintenance Costs - Present Value of Salvage Value)

By subtracting the total present value of costs from the total present value of lease payments, we can determine the Net Advantage of Lease (NAL). If the NAL is positive, it indicates that leasing is advantageous compared to buying, whereas if the NAL is negative, it indicates that buying is advantageous compared to leasing.