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Leasing Lease Financing. Corporate Finance ANSWERS CLASS ASSIGNMENTS Shanghai Spring 2014. Class assignment Leasing: Assume the following case;.
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LeasingLease Financing Corporate Finance ANSWERS CLASS ASSIGNMENTS Shanghai Spring 2014
Class assignment Leasing:Assume the following case; • A company considers and investment of $100; the asset is depreciated over 2 years straight line; no residual value and tax rate 40%; if the company borrow the money the interest is 10% per year • A guideline lease requires a yearly lease fee of $55 • Estimate the cash flows under the 2 scenarios; which has the lower present value? (assume dcf=6% this is the after tax cost of debt: 10%*(1-40%))
So calculate the PV (at 6%) • Buy/Borrow PV(6%): $ 63.33 • Lease PV(6%): $60.50 • The PV of the cost of Financing is lower under leasing…so…LEASE!
Class Assignment: Leasing • Consider a $10 M investment (10 year life) to be discontinued after 5 year • Borrow at 10% interest per year (before tax) if you Buy the Equipment • After 5 years residual value $2 M • A 5 year lease would trigger annual lease payments of $ 2,6M starting immediately in t=0 • Under the lease the lessor maintains the equipment • If the company buy/borrow this equipment the maintenance cost will need to be paid additionally at $0.5M per year at the beginning of each year starting immediately (t=0) • Tax rate of the Lessee is 35% • Modified Accelerated Cost Recovery System (MACRS) depreciation: over the 5 years is resp. 20%, 32%, 19%, 12% and 11% • Compare the PV of the cost of owning (buy/borrow) with the PV of the cost of leasing….which one is lower?
Class assignment: From the Lessor’s point of view • Assuming: • Lessor’s tax rate is 40% • Lessor’s alternative investment is a 5 year bond with an after tax yield of 9%(1-40%)=5.4% • Asset will be depreciated to book value of $600,000 after 5 years and the before tax residual value is $ 2M • This implies that Lessor can expect to receive $2M – 40%*$1.4M=$1,440,000 after the lease expires selling the asset directly… • Develop the cash flows and determine the IRR% of this investment • Is 5.4%>,< or= IRR%? So what would the lessor invest his money in in the Lease or the Bonds…?
