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Part 3: Lease Financing

The Clarkton Company produces industrial machines, which have five-year lives. Clarkton is willing to either sell the machines for $30,000 or lease them at a rental that because of competitive factors yields an after-tax return to Clarkton of 6% (its cost of capital).

Question A: What is the company's competitive lease-rental rate? (Assume straight-line depreciation, zero salvage value, and an effective corporate tax rate of 40%.)

Question B: The Stockton Machine Shop is contemplating the purchase of a machine exactly like those rented by Clarkton. The machine will produce net benefits of $10,000 per year. Stockton can purchase the machine for $30,000 or rent it from Clarkton at the competitive lease-rental rate. Stockton's cost of capital is 12%, its cost of debt 10%, and %. Which alternative is better for Stockton?

Question C: If Clarkton's cost of capital is 9% and competition exists among lessors, solve for the new equilibrium rental rate. Will Stockton's decision be altered?

 

Reference no: EM13864977

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