Tax Rate

IRR
Discount Rate
Cost of Capital, After-Tax
Low risk
Average Risk
High Risk

40%
25%
12%
12%
14%
16%

Equipment Cost
Maintenance Cost
Lease Payments
Residual Value

$
$
$
$

Macrs Depreciation
Year

1,500,000
75,000
475,000
255,000

MACRS rate
1
2
3
4
5
6

0.200
0.320
0.190
0.120
0.110
0.060

Cost of Owning
Year 0
Equiptment cost
Maintence
Maintence Tax Savings
Depreciation Tax Shield
Residual Value
Tax on Residual Value
Net Owning CF

$
$
$
$
$
$
$

(1,500,000)
(75,000)
30,000
(1,545,000)

Cost of Leasing
Lease Payments
Payment Tax Savings
Net Leasing CF

$
$
$

(475,000)
190,000
(285,000)

Year 0
Equiptment Cost
Maintence
Maintence Tax Savings
Depreciation Shield
Residual Value
RV Tax
Lease Payment
Lease Payment Tax
Net CF

$
$
$
$
$
$
$
$
$

(1,500,000)
(75,000)
475,000
(1,100,000)

Year 0
Equiptment Cost
Maintence
Maintence Tax Savings
Interest tax savings
Residual Value
Depreciation Shield
Net Owning CF

Lease Payment
$
$
$
$
$
$
$
$
$
$

$
$
$
$
$
$

Leesee's NAL
455.00 $
460.00
465.00
468.30
470.00
475.00
480.00
481.12
485.00
490.00

$
$
$
$
$
$
$
$
$

(75,000)
30,000
(45,000)

56.67
45.83
34.98
27.83
24.14
13.29
2.45
(8.39)
(19.24)

1 Its not relevant since leases use a firms debt capacity. Therefore, the cost of leasing should be compared to the cos

the firm to high amounts of risk.

2 Agro Chem should lease the equipment if the after tax cost of capital is above 12%. The respective NAL's are as fo
Low-risk
NAL
$
13,294.85

3 The appropriate discount rate is the after-tax cost of debt, because the firm does not own the equipment, and if the
lose control of the equipment. In addition, legal contracts are binding. In regards to the risk of the residual value, t
that the company will receive the residual value of $255,000. However, leases are regarded as another form of fina
4 The analysis would need to include the remaining years of the equipments life, which is shown below.
Year 0
Cost of Leasing
Lease Payments
$
(475,000)
Payment Tax Savings
$
190,000
Cost of Owning
Equiptment cost
$
Maintence
$
Maintence Tax Savings
$
Depreciation Tax Shield
$
Residual Value
$
Tax on Residual Value
$
Net Owning CF
$
(285,000)
NPV @ 7.2%
$
(1,254,885.82)

However, this would only occur due to unforseen circumstances, and as far as the analysis for the next 4 years, this

5 It does not meet the first 3 conditions to be classified as a financial lease because of the $75,000 dollar maintenanc
as follows:
$
1,030,205
90% of Value
$
1,350,000

6 The capital budgeting decisions would not be changed because the the after tax interest rate embedded in the lease
7

Probability

Residual Value
25.0% $
50.0% $
25.0% $

255,000
510,000

The higher residual values show favor for owning while the lower shows favor for leasing.

8 From the perspective of the Lessor Lone Star Capital Inc., it is better for the company to lease the equipment inste
NPV
$
3,724.07

IRR

12.17%
7.824

Agro-Chem, Inc.

Annual Depreciation
$
$
$
$
$
$

300,000
480,000
285,000
180,000
165,000
90,000

Book Value
$
$
$
$
$
$

1,200,000
720,000
435,000
255,000
90,000
Part A: Lesee's Analysis

Year 1
$
$
$
$
$
$

$
$
$

Year 2
(75,000)
30,000
120,000
75,000

$
$
$
$
$
$

(75,000)
30,000
192,000
147,000

(475,000) $
190,000 $
(285,000) $

(475,000)
190,000
(285,000)

Part B: Lessor Analysis

Year 1
$
$
$
$
$
$
$
$

Year 2
(75,000)
475,000
400,000

$
$
$
$
$
$
$
$

(75,000)
475,000
400,000

Alternative Amortization
Year 1

Year 2

$
$
$
$

(493,852)
(75,000)
30,000
72,000

$
$
$
$

(493,852)
(75,000)
30,000
56,940

$
$

120,000 $
(346,852) $

192,000
(289,912)

Lessors NPV
$

(45.25)

$
$
$
$
$
$
$
$
$

(28.24)
(11.23)
5.78
22.79
39.80
43.61
56.81
73.82

re, the cost of leasing should be compared to the cost of debt financing because leasing and borrowing expose

capital is above 12%. The respective NAL's are as follows:

Average risk
High-risk
$
45,510.75 $

76,385.36

ause the firm does not own the equipment, and if the firm were to stop making their lease payments, they would
binding. In regards to the risk of the residual value, the cash flows are less risky because there is a 50% chance
However, leases are regarded as another form of financing with debt.
equipments life, which is shown below.
Year 1

Year 2

$
$

(475,000) $
190,000 $

(475,000)
190,000

$
$
$
$
$
$
$

(285,000)

(285,000)

$
$
$
$
$
$
$

es, and as far as the analysis for the next 4 years, this would have no effect.

ncial lease because of the $75,000 dollar maintenance fee. The true payment is only $400,000 thus the present value of said paym
Since the PV is less than 90% of the asset's value, this lease does not meet any of the conditions of a financial lease.

e the the after tax interest rate embedded in the lease payment is the IRR of the lessees cash flows.
NAL
$
$
$
Total

206,385.41 $
13,294.85 $
(179,795.71) $
$

Weighted Average
51,596.35
6,647.42
(44,948.93)
13,294.85

ower shows favor for leasing.

s better for the company to lease the equipment instead of financing it to them.

>
>

12%
7.20%

Agro-Chem, Inc.

Part A: Lesee's Analysis

Year 3

Year 4

$
$
$
$
$
$

(75,000)
30,000
114,000
69,000

$
$
$

(475,000)
190,000
(285,000) $

$
$
$
$

NAL

72,000
255,000
327,000

Part B: Lessor Analysis

Year 3
$
$
$
$
$
$
$
$

(75,000)
475,000
400,000

$
$
$
$

Alternative Amortization
Year 3
(493,852)
(75,000)
30,000
40,060

$
$

ecause leasing and borrowing expose

Year 4
$
$
$
$
$
$
$
$

$
$
$
$
$
114,000 $
(384,792) $

225,000
225,000

Year 4
(493,852)
30,000
21,170
225,000
72,000
(145,682)

king their lease payments, they would

s risky because there is a 50% chance

Year 3

Year 4

$
$

(475,000) $
190,000 $

$
$
$
$
$
$
$

(285,000)

$
$
$
$
$
$
$

ct.

ent is only $400,000 thus the present value of said payments is

oes not meet any of the conditions of a financial lease.

of the lessees cash flows.

hem.

NPV, Low-risk
$

NPV, Average risk

(1,043,500.32) $
(1,059,714.41)

NPV, Low-risk
$

NPV, Average risk

(1,030,205.48) $
(1,014,203.65)

13,294.85 $

45,510.75

NPV
$

(1,043,494.34)

Year 5
$
$
$
$
$
$
$
$
$

Year 6
(255,000)
(75,000)
30,000
66,000
(234,000)

$
$
$
$
$
$
$
$
$

(75,000)
30,000
36,000
(9,000)

NPV, High-risk
$

(1,075,159.15)

NPV, High-risk
$

(998,773.79)

76,385.36

Year 7
$
$
$
$
$
$
$
$
$

Year 8
(75,000)
30,000
(45,000)

$
$
$
$
$
$
$
$
$

(75,000)
30,000
(45,000)

NPV
$

(1,043,494.34)