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Lease or Buy After Tax Decisions

Our company is considering leasing a diagnostic scanner. The scanner costs $2.5 million and qualifies for a 30 percent CCA rate. Because of radiation contamination, it is valueless in four years. We can lease it for $800,000 per year for 4 years.

Question 1. Assume the tax rate is 37%. You can borrow at 7.5% pretax. Should you buy or lease?

Question 2. What are the cash flows from the lease from the lessor's point of view? (assume 37% tax bracket)

Question 3. What would the lease payment have to be for both lessor and lessee to be indifferent about the lease? (Break-even lease)

Solution Preview

Lease or Buy
Our company is considering leasing a diagnostic scanner. The scanner costs $2.5 million and qualifies for a 30 percent CCA rate. Because of radiation contamination, it is valueless in four years. We can lease it for $800,000 per year for 4 years.

Question 1. Assume the tax rate is 37%. You can borrow at 7.5% pretax. Should you buy or lease?

We will calculate cash flows from the depreciation tax shield first. The depreciation tax shield is:

Depreciation tax shield = ($2,500,000/4)(.37) = $231,250

The aftertax cost of ...

Solution Summary

The expert examines lease or buy after tax decision. The cash flows from the lease and lessor's point of view are determined.

$2.19