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Financing – Debt finance
Example 6
The following information relates to an asset which a company is considering
leasing or buying.
Life of asset 10 years
Cost if purchased $28,000
Residual value $3,000
Lease details: Ten annual repayments of $3,800 to begin at start of
lease.
The shareholders view the adoption of the lease as being an equivalent risk to
borrowing at an after-tax cost of 10% per annum.
The first lease payment (or the purchase price) would be due on 1 January
20X2. The purchase price would not be eligible for tax depreciation
allowances but lease payments would be allowed as a deduction from profit
for tax purposes.
The firm has a 31 December year end and pays corporation tax at 35%, one
year after the year end in which profits are earned.
It makes sufficient profits to obtain tax relief on lease payments as soon as
they arise.
What (to the nearest $100) is the net after-tax benefit of leasing the asset
as opposed to buying it?
A $1,200
B $4,200
C $8,600
D $18,300
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