Calculate the net advantage to leasing

Reference no: EM13299963

A lease calls for payments of $1 million at the end of each of the next five years and payments of $2 million at the end of each of the following five years. The asset to be leased costs $10 million. The 10-year depreciation schedule to a residual value of $500,000 at the end of the lease term is given here. The lessee's marginal income tax rate is currently 40%. Its cost of 10-year secured debt is 12.5%. Its required return for the project is 15% after tax and 17.5% pretax.

a. Calculate the net advantage to leasing.

b. How would your answer to part a change if the lessee did not expect to pay any income taxes for the next three years but to pay income taxes each year thereafter at a 40% rate?

(Hint: Any tax losses in years 1 to 3 can be carried forward and realized in year 4.)

Year 1 2 3 4 5 6 7 8 9 10

Depreciation ($000) 2,000 1,750 1,500 1,250 1,000 400 400 400 400 400

Reference no: EM13299963

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