1. ANSWERS CLASS ASSIGNMENTS Shanghai – FALL 2017
Leasing ACC1
ANSWERS CLASS ASSIGNMENTS
Shanghai – FALL 2017

2. Class assignment Leasing: Assume the following case;
A company considers and investment of $100; the asset is depreciated over 2 years straight line; no residual value and tax rate 40%; if the company borrow the money the interest is 10% per year
A guideline lease requires a yearly lease fee of $55
Estimate the cash flows under the 2 scenarios; which has the lower present value? (assume dcf=6% this is the after tax cost of debt: 10%*(1-40%))

3. Answer: Buy and borrow…cash flows
Year 0
Year 1
Year 2
Cost
-$100
Loan
+$100
Interest
-$10
Tax saving
+$4
Repay loan
Tax saving depreciation
+$20
Total $0
+$14
-$86

4. Answer: Lease cash flows
Year 0
Year 1
Year 2
Lease payment
-$55
Tax saving lease payment
$22
Total $0
-$33

5. So calculate the PV (at 6%)
Buy/Borrow PV(6%): $ 63.33
Lease PV(6%): $60.50
The PV of the cost of Financing is lower under leasing…so…LEASE!

6. Class Assignment: Leasing
Consider a $10 M investment (10 year life) to be discontinued after 5 year
Borrow at 10% interest per year (before tax) if you Buy the Equipment
After 5 years residual value $2 M
A 5 year lease would trigger annual lease payments of $ 2,6M starting immediately in t=0
Under the lease the lessor maintains the equipment
If the company buy/borrow this equipment the maintenance cost will need to be paid additionally at $0.5M per year at the beginning of each year starting immediately (t=0)
Tax rate of the Lessee is 35%
Modified Accelerated Cost Recovery System (MACRS) depreciation: over the 5 years is resp. 20%, 32%, 19%, 12% and 11%
Compare the PV of the cost of owning (buy/borrow) with the PV of the cost of leasing….which one is lower?

7. Answer: cash flows (in $ 1000) if you Borrow and Buy…
MUSD
Yr 0
Yr 1
Yr 2
Yr 3
Yr 4
Yr 5
After tax loan payments
-650
-10,650
Maintenance costs
-500
Maintenance Tax savings
175
DepreciationTax savings
700
1,120
665
420
385
Residual Value
2,000
Tax on residual value
-490
Total Cash Flow
-325
-275
145
-310
-555
-8,755

8. Answer: Leasing MUSD Yr 0 Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 -2,600 910 -1,690
Lease payment
-2,600
Payment Tax savings
910
Net Cash Flow
-1,690

9. Comparing… In 1,000 USD Borrow & Buy Leasing Present Value at 6.5%
(10% after tax 35%)
- 7,534
- 7,480
So: leasing is beneficial
Disadvantage
Advantage (54)

10. Class assignment: From the Lessor’s point of view
Assuming:
Lessor’s tax rate is 40%
Lessor’s alternative investment is a 5 year bond with an after tax yield of 9%(1-40%)=5.4%
Asset will be depreciated to book value of $600,000 after 5 years and the before tax residual value is $ 2M
This implies that Lessor can expect to receive $2M – 40%*$1.4M=$1,440,000 after the lease expires selling the asset directly…
Develop the cash flows and determine the IRR% of this investment
Is 5.4%>,< or= IRR%? So what would the lessor invest his money in in the Lease or the Bonds…?

11. Answer: Lessor’s cash flow (IRR%=5.8% > 5.4% on the Bond….)
Yr 0
Yr 1
Yr 2
Yr 3
Yr 4
Yr 5
purchase price asset
-10,000
Maintenance from t=0
-500
Maintenance tax savings 40%
200
Depreciation tax savings
800
1280
760
480
440
Lease payment
2,600
Tax on lease payment 40%
-1,040
Residual value
2,000
Tax on residual value
( )*40%
-560
Cash flow
-8740
2,060
2,540
2,020
1,740
1,880

12. IRR% calculation in Excel1 2 3 4 5
YEAR
-8740
2,060
2,540
2,020
1,740
1,880
CASH FLOW
5.75%
IRR%