The following stream of after-tax cash flows are available to you as a potential equity investor in a leveraged lease:
The cash flow in year 0 represents the initial equity investment. The positive cash flows in years 1 to 5 result from the tax shield benefits from accelerated depreciation and interest deductibility on the nonrecourse debt. The negative cash flows in years 7 to 9 are indicative of the cash flows generated in a leveraged lease after the earlier-period tax shields have been used. The positive cash flow occurring in year 10 is the result of the asset's salvage value.
a. What problems would you encounter in computing the equity investor's rate of return on this investment?
b. If, as a potential equity investor, you require an 8 percent after-tax rate of return on investments of this type, should you make thisinvestment?