A fiRm Can Either Lease or Buy Some New Equipment

question 236

Multiple Choice

A firm can either lease or buy some new equipment. The lease payments would be $21,600 a year for 4 years. The purchase price is $89,000. The equipment has a 4-year life after which it is
Expected to have a resale value of $7,500. The firm uses straight-line depreciation over the life of
The asset, borrows money at 8.5 percent, and has a 34 percent tax rate. The company does not
Expect to owe any taxes for at least 6 years because it has accumulated net operating losses. What
Is the incremental cash flow for year 3 if the company decides to lease rather than purchase the
Equipment?

• A) -$29,165
• B) -$21,821
• C) -$21,600
• D) -$18,559
• E) -$17,635

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Definitions:

Times Interest Earned

A financial ratio that measures a company's ability to meet its debt obligations based on its current income. It's calculated by dividing earnings before interest and taxes (EBIT) by the interest expenses.

Depreciation Expense

The orderly assignment of the financial value of a real asset over its life of usefulness.

EBIT

The financial performance metric, Earnings Before Interest and Taxes, deducts all expenses from a firm's income except for interest and tax expenses.

Return On Equity

A measure of a corporation's profitability, calculated as net income divided by shareholder's equity, indicating how effectively management is using a company’s assets to create profits.