The lease requires negative cash flows of $27,000 in Years 1-3.
Because the lease payments are tax-deductible at a rate of 34%, the
net negative cash flows are $17,820 in Years 1-3.
The buy scenario is a bit more complicated in that you have not
provided information regarding the repayment schedule. Therefore, I
have computed the results using two typical possibilities.
The first involves a repayment schedule wherein the principal is
repaid over the three years in equal parts and the interest payment
each year is calculated based on the outstanding balance at the
beginning of the year. Therefore, a principal payment of $25,000 is
made in each of the three years, while the interest payments are
$7,500 in year 1, $5,000 in year 2, and $2,500 in year 3.
Because we can use straight-line depreciation, the depreciation in
each year is $25,000.
Both the interest payments and the depreciation are tax-deductible at
a rate of 34%, leading to tax credits of $11,050, $10,200, and $9,350
in Years 1-3. Therefore, the net negative cash flows from the
purchase are $21,450, $19,800, and $18,150 in Years 1-3.
We could do a net present value calculation for both the lease and buy
scenario at this point, but that is not necessary since the negative
cash flows from buying are higher than those from leasing in each
year. Therefore, leasing is more attractive.
The other repayment schedule I considered was an interest payment of
10% on the full amount each year with a balloon payment at the end of
the three-year term. This results in interest payments of $7,500 per
year, and a principal repayment of $75,000 in the third year.
The tax credits from the depreciation and interest payments are
$11,050 for all three years in the scenario. The payment cash flows
are $7,500 in the first year, $7,500 in the second year, and $82,500
in the third year. After taxes, the net cash flows are $3,550 in the
first year and second years, and -$71,450 in the third year.
Because the cash flows differ in sign and magnitude between the lease
and purchase options, we will have to calculate the net present value
to determine which approach is best.
Net present value is calculated by the formula: cash flow (period
n)/(1 + interest rate) ^ period n.
For the lease, using the interest rate of 10%, the net present value
is -$44,315.70.
For the second purchasing scenario, using the interest rate of 10%,
the net present value is -$47,520.29. Therefore, despite postponing
the repayment of principal until the end of the third year, leasing is
still more attractive.
Please request clarification if needed. Thank you for requesting my
services.
Sincerely,
Wonko |
