1.	Lease or Buy. Your company wants to purchase a new network file
server for its wide-area computer network.  The server costs $75,000. 
It will be completely obsolete in three years.  Your options are to
borrow the money at 10 percent or to lease the machine.  If you lease,
the payments will be $27,000 per year, payable at the end of each of
the next three years.  If you buy the server, you can depreciate it
straight-line to zero over three years.  The tax is 34 percent. 
Should you lease or buy?

Hi again dear wombat319!!

To make a decision here we must compare the lease option against the
buy option. In order to do that we must find the cash flows of
2leasing instead buying":
 
Cost of new server = $75,000
Tax rate = 34% = 0.34

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

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

Loan cash flows:
Assuming that you borrow  $75,000 in order to buy the server, you will
pay the interest of $7,500 yearly, and at the third year you must add
the capital payment of $75000. Then the cash flows related to the loan
are:
Year 0: $75,000     (positive --> you receive the cash)
Year 1: -$7,500     (negative --> it is a payment) 
Year 2: -$7,500            "            "
Year 3: -$82,500           "            "

Interest payments are tax-deductible, and generates tax credits of:
Tax shields on interest = $7,500*0.34 = $2,550 

Now we can calculate the cash flows that results from the leasing instead buying:

                       Year 0     Year 1     Year 2     Year 3 
                   ------------------------------------------------  
Cost of Equipment    $75,000  (this is a cash inflow because you does
not pay for the equipment, you are leasing!!)

Loan cash flows     -$75,000      $7,500     $7,500    $82,500

Lost on interest tax shield      -$2,550    -$2,550    -$2,550

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

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

Savings on tax shields on lease   $9,180     $9,180     $9,180
                   --------------------------------------------------
Net Cash Flow          $0       -$21,370   -$21,370    $53,630


Some clarifications are needed:
ˇYou are not paying for the new equipment, then you are saving the
initial investment of $75,000, for the purposes to compare the lease
vs buy this is equivalent to a cash inflow of $75,000 (ie a positive
cash flow).
ˇThe loan related cash flows change their sign because you are leasing
and: a) you do not receive the capital; and b) you are not paying the
loan.
ˇYou are leasing, then you cannot save taxes from depreciation and
interests, these are cash inflows not received, then these cash flows
are negative.
ˇYou are saving the tax shields on lease, then these cash flows are positive.

The Interest rate (R) is 10%, then the PV of the above cash flows are:

                 CF1           CF2            CF3        
PV  = CF0  +  ---------  +  ----------  +  ----------  =
              (1.1)^1         (1.1)^2	     (1.1)^3    

    = $0 + (-$19,427.27) + (-$17,661.16) + ($40,293.01) =

    = $3,204.58


We have found that the present value of the "Lease vs Buy" cash flows
discounted at the cost of capital rate of 10% is positive, this means
that to lease is a better option than to buy the server. You must
lease the new server.

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

I hope that this helps you. Feel free to request for a clarification
if you need it.

Best regards.
livioflores-ga

Thanks my friend! This might be the last one, but I have a few more
things to read that I probably won't understand and I know you're out
there to help. You're great!