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 the 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)

Jaemarie --

You can calculate the lease payments in 3 steps ?

Step 1: Calculate the Net Present Value (NPV) of the amount to be amortized.

Step 2: Calculate the annual after-tax required lease income. By
taking your answer from Step 1 as an NPV then  use the number of years
and the required rate of return to get the required payment.

Step 3: 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 1 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.  Even
without Excel, it's viewable in your browser:

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 before rating this Google Answer.

Best regards,

Omnivorous-GA

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Request for Answer Clarification by jaemarie-ga on 20 Sep 2005 05:56 PDT

Please may I have some more guidance on this,  I am not good at using
excel or am I good at NPV calculations

---

Clarification of Answer by omnivorous-ga on 20 Sep 2005 08:23 PDT

Jaemarie --

Setting up NPV factors is probably the most-difficult part
(independent of the treatment of salvage value in cash flow).

Each year, you'll be discounting the cash coming in by your
rate-of-return.  So, for each year it's:

Year 0 (today): 1
Year 1: 1/1.14^1 = 0.877192982
Year 2: 1/(1.14)^2 = 0.769467528
Year 3: 1/(1.14)^3 = 0.674971516
Year 4: 1/(1.14)^4 = 0.592080277
Year 5: 1/(1.14)^5= 0.519368664

I hope that this helps.

Best regards,

Omnivorous-GA

Try these: 

http://www.justanswer.com/JA/ASP_A/T_75792/TR/finance.htm?get=last 

http://www.elgss.brainmass.com/homeworkhelp/business/finance/40659/