Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
CHAPTER 21
THE DECISION TO LEASE OR BUY AT
WARF COMPUTERS
1. The decision to buy or lease is made by looking at the incremental cash flows. The incremental cash
flows from leasing the machine are the security deposit, the lease payments, the tax savings on the
lease, the lost depreciation tax shield, the saved purchase price of the machine, and the lost salvage
value. The salvage value of the equipment in four years will be:
Aftertax salvage value = $780,000 – $780,000(.21)
2. The book value of the equipment in Year 2 will be:
Book value = $6,100,000 – $6,100,000(.3333 + .4445)
Book value = $1,355,420
So, the aftertax salvage value in Year 2 will be:
Aftertax salvage value = $3,200,000 + ($1,355,420 – 3,200,000)(.21)
3. a. The inclusion of a right to purchase the equipment will have no effect on the value of the lease.
If the company does not purchase the equipment, it can go on the market and purchase identical
equipment at the same price.
4. The cancellation option is also a real option. The cancellation option is a put option on the equipment.
