Question

Imagine yourself in the position of Thomas Pierce III, president of Greymare Bus Lines. Your firm was established by your grandfather, who was quick to capitalize on the growing demand for transportation between Widdicombe and nearby townships. The company has owned all its vehicles from the time the company was formed; you are now reconsidering that policy. Your operating manager wants to buy a new bus costing $95,000. The bus will last only eight years before going to the scrap yard. You are convinced that investment in the additional equipment is worthwhile. However, the representative of the bus manufacturer has pointed out that her firm would also be willing to lease the bus to you for eight annual payments of $16,400 each. Greymare would remain responsible for all maintenance, insurance, and operating expenses. Greymare no longer owns the bus, and so it cannot depreciate it. Therefore it gives up a valuable depreciation tax shield. We assume depreciation would be calculated using five-year tax depreciation (MACRS) schedules. Greymare’s cost of capital is 8%, borrowing rate is 10% and the tax rate is 35%.

Required:
(a) What is the value of the lease if Greymare’s marginal tax rate is 20%? (Round your answer to the nearest dollar amount. Negative amount should be indicated by a minus sign. Omit the "$" sign in your response.)

(b) What would the lease value be if Greymare had to use five-year straight-line depreciation for tax purposes? (Round your answer to the nearest dollar amount. Negative amount should be indicated by a minus sign.Omit the "$" sign in your response.)

Nodhead College needs a new computer. It can either buy it for $295,000 or lease it from Compulease. The lease terms require Nodhead to make six annual payments (prepaid) of $71,000. Nodhead pays no tax. Compulease pays tax at 35%. Compulease can depreciate the computer for tax purposes over five years (MACRS). The computer will have no residual value at the end of year 5. The interest rate is 6%.

Required:
(a) What is the NPV of the lease for Nodhead College? (Round your answer to the nearest dollar amount. Negative amount should be indicated by a minus sign. Omit the "$" sign in your response.)
(b) What is the NPV for Compulease? (Round your answer to the nearest dollar amount. Omit the "$" sign in your response.)
(c) What is the overall gain from leasing? (Round your answer to the nearest dollar amount. Negative amount should be indicated by a minus sign. Omit the "$" sign in your response.)

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