Question

The Benton Company has decided to acquire some new R&D equipment. One alternative is to lease the equipment on a 4-year guideline contract for a lease payment of $11,500 per year, payments to be made at the beginning of each year. The lease, which would include maintenance, is being offered by lePage Credit Corporation, a local leasing company. LePage would purchase the equipment outright for $40,000, and would have to pay the local dealer $1,000 at the beginning of each year to provide maintenance service. The equipment falls into the MACRS 3-year class, and it has a residual value of $10,000, which is the expected market value after 4 years. The lessor’s marginal state-plus-federal tax rate is 40 percent. The analysts at LePage compare the returns on potential leases with returns available on comparable maturity commercial bank loans which the firm also writes. Currently, LePage is charging 9 percent on 4- year commercial loans. Based on the NPV analysis, Should LePage write the lease? Why or why not?

a) Yes, because the NPV is positive.
b) No, because the NPV is negative.
c) Yes, because the lease payment is low.
d) No, because the equipment has a high residual value.

Answer 1

The Benton Company has decided to acquire some new R&D equipment. One alternative is to lease the equipment on a 4-year guideline contract for a lease payment of $11,500 per year, payments to be made at the beginning of each year.The lessor’s marginal state-plus-federal tax rate is 40 percent. The analysts at LePage compare the returns on potential leases with returns available on comparable maturity commercial bank loans which the firm also writes is Yes, because the NPV is positive.Thus the option a) Yes, because the NPV is positive is correct.

Step-by-step explanation:

LePage Credit Corporation should write the lease because the Net Present Value (NPV) is positive. The NPV analysis involves comparing the present value of cash inflows (lease payments) and outflows (costs and expenses) over the lease period. A positive NPV indicates that the lease is financially viable and would add value to the company.

To elaborate, the NPV calculation considers the cash flows associated with the lease, including the lease payments and maintenance costs, discounted to their present value. The equipment's residual value is also factored in. If the resulting NPV is positive, it suggests that the present value of expected cash inflows exceeds the present value of cash outflows, making the lease financially attractive.

Comparing the NPV to the cost of obtaining funds elsewhere, such as through a commercial bank loan, ensures that LePage makes an informed decision. In this case, the positive NPV indicates that leasing is a favorable option compared to bank loans. Therefore, option a) is the correct choice, as it accurately reflects the positive NPV and supports the decision for LePage to write the lease.

In summary, a positive NPV signifies that the leasing arrangement is financially sound, taking into account all relevant cash flows and discount rates. LePage Credit Corporation should proceed with the lease, as it represents a financially advantageous decision based on the NPV analysis.

Thus the option a) Yes, because the NPV is positive is correct.