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 Subject: finance/ accounting Category: Business and Money > Accounting Asked by: muntzster-ga List Price: \$12.50 Posted: 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?```
 ```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``` Request for Answer Clarification by muntzster-ga on 02 Sep 2005 19:00 PDT `The market value is 2 million.` Clarification of Answer by omnivorous-ga on 02 Sep 2005 19:28 PDT ```Tracy -- Thanks for the kind words and the extra sum. I should point out that there's an alternate way to look at (and answer) this question. Depreciation could also be set up on the net value of the project -- or \$165,000 over the 5 years. That's not the assumption in this question, of course. And in real life, projecting salvage value is no easier than projecting the weather in 5 years, so it's rarely done this way. Best regards, Omnivorous-GA```
 muntzster-ga rated this answer: and gave an additional tip of: \$2.00 `Awesome job. Thanks for helping me out. Tracy`