Question

Howell Auto Parts is considering whether to borrow funds and purchase an asset or to lease the asset under an operating lease arrangement. If the company purchases the asset, the cost will be \(10,000. It can borrow funds for four years at 12 percent interest. The firm will use the three-year MACRS depreciation category (with the associated four-year write-off). Assume a tax rate of 35 percent.

The other alternative is to sign two operating leases, one with payments of \)2,600 for the first two years, and the other with payments of $4,600 for the last two years. In your analysis, round all values to the nearest dollar.

b. Compute the annual payment for the loan (round to the nearest dollar).

Short answer

The annual payment for the loan is $3,292.

Step-by-step solution

Information provided in question

Cost of asset = $10,000

Interest rate =12%

Lease term = 4 years

Calculation of annual payment of the loan

The annual payment of the loan is $3,292.

$$\begin{gathered} \text{Annual payment}=\frac{\text{PV}}{{\text{PVIFA}}_{\left(i=12\%,n=4years\right)}} \\ =\frac{\$10,000}{3.0373} \\ =\$3,292 \end{gathered}$$