Response to the following questions:
1. What is a synthetic lease?
2. The Mishthosi Company is considering the acquisition of a machine that costs $50,000 if bought today. The company can buy or lease the machine. If it buys the machine, the machine would be depreciated as a 3-year MACRS asset and is expected to have a salvage value of $1,000 at the end of the 5-year useful life. If leased, the lease payments are $12,000 each year for four years, payable at the beginning of each year. The marginal tax rate of Mishthosi is 30% and its cost of capital is 10%. Assume that the lease is a net lease, that any tax benefits are realized in the year of the expense, and that there is no investment tax credit. MACRS rates of depreciation on a 3-year asset are:
|
Year
|
Rate
|
|
1
|
33.33%
|
|
2
|
44.45%
|
|
3
|
14.81%
|
|
4
|
7.41%
|
a. Calculate the depreciation for each year in the case of the purchase of this machine.
b. Calculate the direct cash flows from leasing initially and for each of the five years.
c. Calculate the adjusted discount rate.
d. Calculate the value of the lease.