I want to purchase some new equipment.  The cost is 75,000.  It will
be obsolete in 3 years.  I can either borrow the money at 10% or lease
the equipment.  Lease payments are 27,000 per year due at the end of
each of the next 3 years.  If I purchase the equipment, I can
depreciate it straight line to zero over 3 years.  Tax is 34%.  Should
I lease or buy?

Hi kaylo1011!!


Cost of equipment = $75,000
Tax rate = 0.34

Depreciation (straight line) = $75,000 / 3 = $25,000 per year
Tax shield on depreciation = $25,000*0.34 = $8,500

Lease payments = $27,000
Tax shields on lease = $27,000*0.34 = $9,180


With the above information we can construct the Cash flows that
results from the leasing:

                       Year 0     Year 1     Year 2     Year 3 
                   ------------------------------------------------  
Cost of Equipment    $75,000  (because you must not pay for the equipment)

Lost on depreciation tax shield  -$8,500    -$8,500    -$8,500

Lease payments                  -$27,000   -$27,000   -$27,000

Tax shields on lease              $9,180     $9,180     $9,180
                   --------------------------------------------------
NCF                  $75,000    -$26,320   -$26,320   -$26,320


Notes:
Due you not pay the new equipment you are saving the initial
investment of $75,000, for the purposes to compare the lease vs buy
this is equivalent to a cash flow of $75,000 .
Because you are leasing, you cannot save depreciations from taxes,
then you lose the tax shield on depreciation, then the cash flows are
negative.


The Interest rate is 10% and the tax rate is 34%, then the after tax
interest rate is:
Ater Tax interest rate (A) = r*(1-T) = 0.10*(1-0.34) = 0.066  (6.6%)

                 CF1           CF2            CF3        
PV  = CF0  +  ---------  +  ----------  +  ----------  =
              (1 + A)^1     (1 + A)^2	  (1 + A)^3    

    = $75,000 + (-$24,690) + (-$23,162) + (-$21,728) =

    = $5,420


Discounting the above cash flow at the after tax interest rate
(A=6.6%) we find that the lease option (against the buy option) has
positive PV, then to lease is better than to buy. You must lease the
new equipment.

-----------------------------------------------------------

I hope that this helps you. Please use the request for a clarification
feature if you need it before rate this answer, I will gladly respond
your requests for further assistance on this topic.


Best regards.
livioflores-ga

aside from the mathematical conclusion, there are many other reasons
to use an equipment lease when purchasing a piece of equipment, I
thought this info might be helpful in assisting you in making a
decision. enjoy the info and good luck!

http://www.qlease.com/why-lease.htm