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.

f. Compute the present value of the after-tax cost of the two alternatives. Use a discount rate of 8 percent.

Short answer

The present value of the after-tax cost of leasing is $7,585 and of borrow-purchase is $6,937.

Step-by-step solution

Information provided in the question

Annual payment = $3,292

Interest rate = 12%

Discount rate = 8%

Computation of present value of the after-tax cost of both alternatives

Year	After-tax cost of leasing	PV factor at 8%	Present value	After-tax cost of borrow-purchase	PV factor at 8%	Present value
1	$1,690	0.926	$1,565	$1,706	0.926	$1,580
2	$1,690	0.857	$1,448	$1,402	0.857	$1,202
3	$2,990	0.794	$2,374	$2,540	0.794	$2,017
4	$2,990	0.735	$2,198	$2,909	0.735	$2,138
			$7,585			$6,937