Net Advantage to Leasing Question
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Neighborhood Savings Bank is considering leasing $100,000 worth of computer equipment. A 4 year lease would require payments in advance of $22,000 per year. The bank does not currently pay income taxes and does not expect to have to pay income taxes in the foreseeable future. If the bank purchased the computer equipment, it would depreciate the equipment on a straight-line basis down to an estimated salvage value of $20,000 at the end of the 4th year. The bank's cost of secured debt is 14%, and its cost of capital is 20%. Calculate the net advantage to leasing.
My Answer...
COST OF OWNING
Equipment Cost $(100,000)
Loan Amount $100,000
Interest (year 1-4) $(14,000) $(14,000) $(14,000) $(14,000)
Repayment of loan (year 4) $(100,000)
Residual value (year 4) $(20,000)
Net cash flow (year 1-4) $(14,000) $(14,000) $(14,000) $(94,000)
PV ownership CF @14% $(88,158.39)
Cost of Ownership $88,158.39
COST OF LEASING
Lease payments (year 1-4) $(22,000) $(22,000) $(22,000) $(22,000)
Net cash flow (year 1-4) $(22,000) $(22,000) $(22,000) $(22,000)
PV of leasing CF @ 14% $(64,101.67)
Cost of Leasing $64,101.67
NAL = Cost of Ownership - Cost of Leasing = $24,056.72
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Solution Summary
This solution illustrates how to compute the net advantage to leasing when the entity's cost of secured debt differs from its cost of capital.
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