Question

ou work for a nuclear research laboratory that is contemplating leasing a diagnostic scanner (leasing is a common practice with expensive, high-tech equipment). The scanner costs $6,900,000, and it would be depreciated straight-line to zero over four years. Because of radiation contamination, it will actually be completely valueless in four years. You can lease it for $1,935,000 per year for four years. Assume that the tax rate is 35 percent. You can borrow at 10 percent before taxes.

Answer 1

To analyze the financial impact of leasing the diagnostic scanner, we need to compare the cost of leasing to the cost of purchasing and depreciating the equipment.

1. Cost of Leasing: The lease cost is $1,935,000 per year for four years, resulting in a total cost of $7,740,000 over the lease term.

2. Cost of Purchasing and Depreciating: The scanner costs $6,900,000 and will be depreciated straight-line to zero over four years. Therefore, the annual depreciation expense would be $1,725,000 ($6,900,000 divided by 4 years).

3. Tax Considerations: Assuming a 35 percent tax rate, the tax savings from depreciation can be calculated. The tax savings each year would be equal to the depreciation expense multiplied by the tax rate ($1,725,000 x 0.35 = $603,750).

Now, let's calculate the net cash flows for both options:

Leasing: -$7,740,000 (total lease cost)

Purchasing and Depreciating:

Year 1: -$6,900,000 (equipment cost)

Year 2: -$1,725,000 (depreciation expense)

Year 3: -$1,725,000 (depreciation expense)

Year 4: -$1,725,000 (depreciation expense)

Tax Savings: +$603,750 (tax savings from depreciation each year)

To determine the net cash flows, we need to subtract the tax savings from the depreciation expenses:

Year 1: -$6,900,000

Year 2: -$1,121,250 ($1,725,000 - $603,750)

Year 3: -$1,121,250 ($1,725,000 - $603,750)

Year 4: -$1,121,250 ($1,725,000 - $603,750)

Now, let's calculate the present value of the net cash flows by discounting them at a rate of 10 percent:

Year 1: -$6,900,000 / (1 + 0.10) = -$6,272,727

Year 2: -$1,121,250 / (1 + 0.10)^2 = -$923,553

Year 3: -$1,121,250 / (1 + 0.10)^3 = -$760,041

Year 4: -$1,121,250 / (1 + 0.10)^4 = -$625,536

Next, we sum up the present values of the net cash flows:

-$6,272,727 + (-$923,553) + (-$760,041) + (-$625,536) = -$8,581,857

Comparing the present value of the net cash flows from purchasing and depreciating ($8,581,857) to the lease cost ($7,740,000), we can see that leasing the diagnostic scanner would be the more cost-effective option.

Therefore, based on the financial analysis, it would be more advantageous for the nuclear research laboratory to lease the diagnostic scanner rather than purchasing and depreciating it.