Raymond Rayon Corporation wants to expand its manufacturing facilities. Liberty Leasing Corporation has offered Raymond Rayon the opportunity to lease a machine for $100,000 for five years. The machine will be fully depreciated by the straight-line method. The corporate tax rate for Raymond Rayon is 25 percent, while Liberty Leasing corporate tax rate is 35 percent. The appropriate before-tax interest rate is 8 percent. Assume lease payments occur at year-end. What is Raymond's reservation price? What is Liberty's reservation price? What is the negotiating range of the lease?
The reservation price is the least amount that would be acceptable as leas payments. It is calculated by setting the NPV of the cash flows = 0.
NPV = Cost - PV of lease payments, setting NPV=0 we get
0 = Cost - PV of lease payments
a. Raymond Reservation Price
The cash flows for Raymond are
The cost of the machine is $100,000. Let L be the lease payments to be made. There will be tax benefit, so we ...
The solution explains how to determine the negotiating range of the lease.