Category: Business and Money > Accounting
Asked by: muntzster-ga
List Price: $12.50
02 Sep 2005 17:00 PDT
Expires: 02 Oct 2005 17:00 PDT
Question ID: 563721
Leases R Us, Inc. (LRU) has been contracted by Robotics of Beverly Hills (RBH) to provide lease financing for a machine that would assist in automating a large part of their current assembly line. Annual lease payments will start at the beginning of each year. The purchase price of this machine is $200,000, and it will be leased by RBH for a period of 5 years. LRU will utilize straight line depreciation of $40,000 per year with a zero book salvage value. However, salvage value is estimated to actually be $35,000 at the end of 5 years. LRU is required to earn a 14% after tax rate of return on the lease. LRU uses a marginal tax rate of 40%. Calculate the annual lease payments. (Remember, these payments are to be considered at the beginning of each year ? annuity due.) Please show me how to calculate this?
Re: finance/ accounting
Answered By: omnivorous-ga on 02 Sep 2005 17:34 PDT
Muntzster -- You can calculate the lease payments in 3 steps ? Step A: Calculate the Net Present Value (NPV) of the amount to be amortized. Step B: Calculate the annual after-tax required lease income. By taking your answer from Step A as an NPV then use the number of years and the required rate of return to get the required payment. Step C: Calculate the lease payment by taking the answer from Step B and adjusting for taxes. You?ll divide it by (1 - the tax rate). In Step A it?s very important to note that the salvage value of the machine ($35,000) will get discounted for net present value (NPV) ? but not for tax effects. Why no taxes? Because the leasing company is already showing a -$40,000 income ? and the salvage simply reduces the loss. In other words, a company that?s losing money doesn?t have to worry about paying taxes on any gains that are less than its losses. The calculations in the three steps are all in this Excel spreadsheet, which your browser should be able to read, even if you don?t have Excel itself. By netting up the year 5 salvage and depreciation, we avoid the potential error mentioned in the previous paragraph. If you do have Excel, you can download and change the spreadsheet: NPV Cash Flow http://www.mooneyevents.com/npvlease1.xls If you have any questions about these calculations, please let us know via a Clarification Request. Best regards, Omnivorous-GA
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Awesome job. Thanks for helping me out. Tracy
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