Question: A firm has decided to acquire a particular asset. Annual lease payments, to be made at the end of each year, amount to 20 percent of the assets original value. The firm could borrow at an interest rate of 10 percent. Capital cost allowances on the asset would be taken at a rate of 20 percent, and the firm's tax rate is 45 percent. The asset has no salvage value at the end of its economic life.
(a) Assume an economic life of 6 years. What is the after-tax cost implicit in leasing? Round to the nearest percentage point.
(b) Assume that the firm is uncertain about the economic life of the asset, and that a lease has been offered that can be cancelled on an annual basis. How long would the economic life of the asset have to be (round up to the nearest year) for owning and borrowing just to become attractive?