CORPORATE FINANCIAL MANAGEMENT, Fourth Edition

Solutions Manual, Chapter 21

Chapter 21
Questions
1.

A lease is a rental agreement that extends for one year or longer. The owner of the asset that is being rented is the lessor,
and the entity that is renting the asset is the lessee.

2.

The advantages of leasing are efficient use of tax deductions and tax credits, reduced risk, reduced costs of borrowing,
flexibility under bankruptcy, circumvention of debt covenants, and off balance sheet financing. The disadvantages of
leasing are that the lessee forfeits the tax deductions associated with ownership and usually forgoes the residual value.
The advantages of leasing that are of dubious value are trying to fool investors through accounting games, achieving
100% financing, and circumventing debt covenants.

3.

A dollar of lease financing replaces a dollar of debt financing because a firm must meet its lease payment obligations on
time in order to have uninterrupted use of the leased asset. If the lessee misses a lease payment, the lessor can reclaim
the asset and sue for the missed lease payment. The consequences are similar to those of missing an interest or principal
repayment.

4.

The principal tax benefits associated with asset ownership are investment tax credits and depreciation tax shields.

5.

To qualify as a true lease for tax purposes, the lease cannot exceed 80% of the useful life of the asset, the lessor must
maintain a 10% minimum equity investment in the asset, the lessee must not pay any portion of the purchase price of the
asset, and the lessor must hold title to the property.

6.

The net advantage to leasing is measured by the difference between the purchase price and the present value of the
incremental after-tax cash flows associated with the lease, discounted at the lessees after-tax cost of similarly secured
debt.

7.

The appropriate discount rate to use when calculating the present value of the incremental after-tax cash flows associated
with a lease financing is the lessees after-tax cost of similarly secured debt. The expected residual value of the asset is
discounted at a higher rate to reflect its greater riskiness as residual value is related to project risk, not financing risk.

8.

Project financing is an appropriate method of financing a capital investment project when the projects assets can stand
alone as an independent economic unit and the project will generate sufficient revenue to service project debts.

9.

The advantages of project financing are risk sharing, expanded debt capacity, and lower cost of debt. The disadvantages
of project financing are the transaction costs associated with the complexity of the arrangements.

10. Lease financing and limited partnership financing are similar in that the arrangements are both types of tax-oriented
financing.

Challenging Questions
11. The argument seems contradictory because it confuses two different decisions and the cash flows connected with each
decision. The first decision is the acquisition decision, which is analyzed by computing the machines NPV. The NPV is
based on the present value of the cash flows the machine will generate, which in turn is based on the assets cost of
capital. The second decision is the choice of leasing versus buying the asset, which is analyzed by computing the net
advantage to leasing (NA). NA is based on the present value of the promised lease cash flows, using the risk-adjusted
required return for those cash flows. Because the contractual lease payments are similar in risk to promised debt
payments, their risk-adjusted required return is the lessee's blended cost of secured and unsecured debt. The total NPV
of acquiring the asset by leasing is the machines NPV plus NA.
12. a. The cost of limited partner capital is a cost of (leveraged) equity capital.
b. The cost of limited partner capital should be compared to the cost of equity capital assuming the firm has the same
leverage ratio as the limited partnership.

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CORPORATE FINANCIAL MANAGEMENT, Fourth Edition

Solutions Manual, Chapter 21

13. a. There are significant agency costs between the mining firm and the bank. If the project is unsuccessful, the mining
firm could abandon the project and allow its subsidiary to go bankrupt, and the bank would lose its investment. The
purchase agreement helps to minimize this agency cost.
b. The bank charges a higher interest rate on this loan than it would on a loan directly to the mining firm because of the
increased risk. A loan directly to the mining firm would be less risky because the firms other projects could
potentially cover the debt if the project was unsuccessful.

Problem Set A
A1.
Month
Outlay
Payment
Salvage
Net CF

0
$25,000
-$500

1
-$500

$24,500

-$500

59

60

-$500

-$500

-$500

-$500

$0
-$8,000
-$8,000

n = 60 r = 9%/12 = 0.75% PV = ? PMT = $500 FV = $7,500 PV = -$28,876.93

NAL = $24,500 - $28,876.93 = -$4,376.93
A2. a. After-tax cost of secured debt = (1 - 0.34) x 12% = 7.92%
NAL = $1,000 - $300 / 1.07921 - $275 / 1.07922 - $250 / 1.07923 - $225 / 1.07924 - $200 / 1.07925
NAL = $1,000 - $277.98 - $236.12 - $198.90 - $165.87 - $136.62 = -$15.49
b. Allied Metals should borrow and buy.
A3. a.
Year
0
1
2
3
4
Outlay
$1,000,000
Payment
-$300,000 -$300,000 -$300,000 -$300,000
Tax Credit
$120,000 $120,000 $120,000 $120,000
Dep Tax Credit
-$72,000 -$72,000 -$72,000 -$72,000
Salvage
Net CF
$1,000,000 -$252,000 -$252,000 -$252,000 -$252,000

5
-$300,000
$120,000
-$72,000
-$100,000
-$352,000

b. NAL = P - [ (1 - T)(CFt - Et) + TDt ] / [ 1 + (1 - T)r ]t - SAL / (1 + r)N - ITC

(1 - T)(CFt - Et) + TDt = (1 - 0.40)($300,000 - $0) + 0.40 x ($1,000,000 - $100,000) / 5 = $252,000
(1 - T)r = (1 - 0.40) x 10% = 6.0000%
N=5 I=12 PMT=252,000 FV=0 PV = -1,061,515.67
N=5 I=12 PMT=0 FV=100,000 PV = -56,742.69
NAL = 1,000,000 - 1,061,515.67 - 56,742.69 = -$118,258.36
A4. a. NAL = P - [ (1 - T)(CFt - Et) + TDt ] / [ 1 + (1 - T)r ]t - SAL / (1 + r)N - ITC
(1 - T)(CFt - Et) + TDt = (1 - 0.35)($135,000 - $0) + 0.35 x ($1,000,000 - $0) / 10
(1 - T)(CFt - Et) + TDt = $122,750
1 + (1 - T)r = 1 + (1 - 0.35) x 10% = 1.065
$122,750 / 1.065 = n = 10 r = 6.5% PV = ? PMT = $122,750 FV = 0 PV = - $882,428.91
+ r)N = $0 / 1.1510 = $0
NAL = $1,000,000 - $882,428.91- $0 = $117,571.09
The firm should lease.
b. NAL = P - [ (1 - T)(CFt - Et) + TDt ] / [ 1 + (1 - T)r ]t - SAL / (1 + r)N - ITC
(1 - T)(CFt - Et) + TDt = (1 - 0.35)($135,000 - $0) + 0.35 x ($1,000,000 - $250,000) / 10
(1 - T)(CFt - Et) + TDt = $114,000
1 + (1 - T)r = 1 + (1 - 0.35) x 10% = 1.065
$114,000 / 1.065 = n = 10 r = 6.5% PV = ? PMT = $114,000 FV = 0 PV = -$819,526.65
SAL / (1 + r)N = $250,000 / 1.1510 = $61,796.18
NAL = $1,000,000 - $819,526.65 - $61,796.18 = $118,677.18
The firm should lease.
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SAL / (1

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CORPORATE FINANCIAL MANAGEMENT, Fourth Edition

Solutions Manual, Chapter 21

A5.
Year Net
Op.
Taxable Dist to Tax
Residual CF to
Proceeds CF
Income Partners Foregone Foregone Sponsor
0
$45.00
$45.00
1
$1.50 -$3.50
$1.35
-$1.26
-$2.61
2
$3.00 -$2.00
$2.70
-$0.72
-$3.42
3
$3.50 -$1.50
$3.15
-$0.54
-$3.69
4
$7.00
$2.00
$6.30
$0.72
-$5.58
5
$10.00
$5.00
$9.00
$1.80
-$7.20
6
$12.00
$7.00 $10.80
$2.52
-$8.28
7
$14.00
$9.00 $12.60
$3.24
-$9.36
8
$16.00 $11.00 $14.40
$3.96
-$10.44
9
$17.50 $12.50 $15.75
$4.50
-$11.25
10
$19.00 $14.00 $17.10
$5.04
$92.34 -$104.40
Cost of Limited Partner Capital = 17.71%
A6. n = 10 r = ? PV = -$50 PMT = $8 FV = $0 r = 9.61%
A7. (Asset Value - Secured Borrowings) / Secured Borrowings = 25%
Asset Value = 1.25 x Secured Borrowings
Secured Borrowings = 1 / 1.25 x Asset Value = 80% x Asset Value
0.80 x 9% + 0.20 x 11% = 9.4%

Problem Set B
B1. NAL = $10.5 million - $3 million / 1.13 - $5 million / 1.132 - $5 million / 1.133
NAL = $0.46 million
B2.

a. NAL = P - [ (1 - T)(CFt - Et) + TDt ] / [ 1 + (1 - T)r ]t - SAL / (1 + r)N - ITC - $2,000

(1 - T)(CFt - Et) + TDt = (1 - 0.00)($335 - $0) + 0.00 x ($20,000 - $6,000) / 48 = $335.00
(1 - T)r = (1 - 0.00) x 9% APR, which is 0.75% per month
N=48 I=0.75 PMT=335 FV=0 PV = -$13,461.90
N=48 I=0.75 PMT=0 FV=6,000PV = -$4,191.68
NAL = 20,000 - 13,461.90 - 4,191.68 - 2,000 = $346.41
b. Honda gives the car at time zero and receives a $2,000 down payment. This is equivalent to a
-20,000 + 2,000 = -$18,000 cash flow. Honda receives the monthly payments:
N=48 I=(1-0.4)8/12=0.40 PMT=335(1-0.4)=201.00 FV=0 PV = -$8,762.44
Honda also receives a depreciation tax credit:
N=48 I=(1-0.4)8/12=0.40 PMT=0.4(20,000-6,000)/48=116.67 FV=0
PV = -$5,086.14
Honda also receives the car or $6,000 at the end of the lease:
N=48 I=8/12 PMT=0 FV=6,000
PV=4,361.52
Hondas lease NPV = -18,000 + 8,762.44 + 5,086.14 + 4,361.52 = $210.10. Therefore, it is also good for Honda.
c. Leasing a car can be mutually advantageous because the manufacturer is able to deduct depreciation while the
consumer is not.

B3. Equation (20.2) assumes the payments are made at the end of each period. If the payments are made at the beginning of
each period, Equation (20.2) is discounting each payment one time too many. The equation can be adjusted by
multiplying each payment by [1 + (1 - T) r ].
[ (1 - T)(CFt - Et) + TDt ] / [ 1 + (1 - T)r ]t x [1 + (1 - T) r ]
The present value of the payments can be simplified by adjusting the exponent from t to t-1.
[ (1 - T)(CFt - Et) + TDt ] / [ 1 + (1 - T)r ]t-1

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CORPORATE FINANCIAL MANAGEMENT, Fourth Edition

Solutions Manual, Chapter 21

B4. a. NAL = P - [ (1 - T)(CFt - Et) + TDt ] / [ 1 + (1 - T)r ]t-1 - SAL / (1 + r)N - ITC
(1 - T)(CFt - Et) + TDt = (1 - 0.34)($7,850 - $0) + 0.34 x ($35,000 - $5,000) / 5
(1 - T)(CFt - Et) + TDt = $7,221
1 + (1 - T)r = 1 + (1 - 0.34) x 10% = 1.066
$7,221 / 1.066: n = 5 r = 6.6% PV = ? PMT = $7,221 FV = 0 PV = -$29,927.35
$29,927.35 x 1.066 = $31,902.55
SAL / (1 + r)N = $5,000 / 1.125 = $2,837.13
NAL = $35,000 - $31,902.55 - $2,837.13 = $260.31
New Horizon should lease.
b. NAL = P - [ (1 - T)(CFt - Et) + TDt ] / [ 1 + (1 - T)r ]t-1 - SAL / (1 + r)N - ITC
(1 - T)(CFt - Et) + TDt = (1 - 0.00)($7,850 - $0) + 0.00 x ($35,000 - $5,000) / 5
(1 - T)(CFt - Et) + TDt = $7,850
1 + (1 - T)r = 1 + (1 - 0.00) x 10% = 1.10
$7,850 / 1.10: n = 5 r = 10% PV = ? PMT = $7,850 FV = 0 PV = -$29,757.68
$29,757.68 x 1.10 = $32,733.44
SAL / (1 + r)N = $5,000 / 1.125 = $2,837.13
NAL = $35,000 - $32,733.44 - $2,837.13 = -$570.57
New Horizon should borrow and buy.
B5.

NAL = P - [ (1 - T)(CFt - Et) + TDt ] / [ 1 + (1 - T)r ]t-1 - SAL / (1 + r)N - ITC

(1 - T)(CFt - Et) + TDt = (1 - 0.00)($22,000 - $0) + 0.00 x ($100,000 - $20,000) / 4
(1 - T)(CFt - Et) + TDt = $22,000
1 + (1 - T)r = 1 + (1 - 0.00) x 14% = 1.14
$22,000 / 1.14: n = 4 r = 14% PV = ? PMT = $22,000 FV = 0 PV = -$64,101.67
$64,101.67 x 1.14 = $73,075.90
SAL / (1 + r)N = $20,000 / 1.204 = $9,645.06
NAL = $100,000 - $73,075.90 - $9,645.06 = $17,279.03

B6.

NAL = P - [ (1 - T)(CFt - Et) + TDt ] / [ 1 + (1 - T)r ]t-1 - SAL / (1 + r)N - ITC

(1 - T)(CFt - Et) + TDt = (1 - 0.00)($33,000 - $0) + 0.00 x ($120,000 - $30,000) / 4
(1 - T)(CFt - Et) + TDt = $33,000
1 + (1 - T)r = 1 + (1 - 0.00) x 14% = 1.14
$33,000 / 1.14: n = 4 r = 14% PV = ? PMT = $33,000 FV = 0 PV = -$96,152.51
$96,152.51 x 1.14 = $109,613.86
SAL / (1 + r)N = $30,000 / 1.204 = $14,467.59
NAL = $120,000 - $109,613.86 - $14,467.59 = -$4,081.45

B7.

NAL = P - [ (1 - T)(CFt - Et) + TDt ] / [ 1 + (1 - T)r ]t - SAL / (1 + r)N - ITC

(1 - T)(CFt - Et) + TDt = (1 - 0.40)($110,000 - $0) + 0.40 x ($800,000 - $50,000) / 10 = $96,000
(1 - T)r = (1 - 0.40) x 12% = 7.2000%
N=10 I=7.20 PMT=96,000 FV=0 PV = -668,074.14
N=10 I=14.00 PMT=0 F=50,000 PV = -13,487.19
NAL = 800,000 - 668,074.14 - 13,487.19 = $118,438.67
Rashid should lease.

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CORPORATE FINANCIAL MANAGEMENT, Fourth Edition

Solutions Manual, Chapter 21

B8. a.
Year
0
1
2
3
4
5
Outlay
$750,000
Payment
-$190,000 -$190,000 -$190,000 -$190,000 -$190,000
Tax Credit
$64,600
$64,600
$64,600
$64,600
$64,600
Dep Tax Credit
-$51,000
-$51,000
-$51,000
-$51,000
-$51,000
Salvage
-$100,000
Net CF
$750,000 -$176,400 -$176,400 -$176,400 -$176,400 -$276,400
b. NAL = P - [ (1 - T)(CFt - Et) + TDt ] / [ 1 + (1 - T)r ]t - SAL / (1 + r)N - ITC
(1 - T)(CFt - Et) + TDt = (1 - 0.34)($190,000 - $0) + 0.34 x ($750,000 - $0) / 5
(1 - T)(CFt - Et) + TDt = $176,400
1 + (1 - T)r = 1 + (1 - 0.34) x 14% = 1.0924
$176,400 / 1.0924: n = 5 r = 9.24% PV = ? PMT = $176,400 FV = $0 PV = -$681,882.98
SAL / (1 + r)N = $100,000 / 1.165 = $47,611.30
NAL = $750,000 - $681,882.98 - $47,611.30 = $20,505.72
B9. a. n = 5 r = 11% x (1 - 0.40) = 6.6% PV = ? PMT = $15 FV = $0 PV = -$62.17
NAL = $50 - $62.17 = -$12.17 million
b. n = 5 r = ? PV = $50 PMT = -$15 FV = 0 r = 15.24%
c. National should borrow and buy.
B10.a.
Year
0
1
2
3
4
Outlay
$25,000
Payment
-$5,000 -$5,000 -$5,000 -$5,000
Tax Credit
$2,000 $2,000 $2,000 $2,000
Dep Tax Credit
-$1,000 -$1,000 -$1,000 -$1,000
Salvage
Net CF
$25,000 -$4,000 -$4,000 -$4,000 -$4,000

-$5,000 -$5,000 -$5,000 -$5,000

$2,000 $2,000 $2,000 $2,000
-$1,000 -$1,000 -$1,000 -$1,000
-$5,000
-$4,000 -$4,000 -$4,000 -$9,000

b. NAL = P - [ (1 - T)(CFt - Et) + TDt ] / [ 1 + (1 - T)r ]t - SAL / (1 + r)N - ITC

(1 - T)(CFt - Et) + TDt = (1 - 0.40)($5,000 - $0) + 0.40 x ($25,000 - $5,000) / 8
(1 - T)(CFt - Et) + TDt = $4,000
1 + (1 - T)r = 1 + (1 - 0.40) x 12% = 1.072
$4,000 / 1.072: n = 8 r = 7.2% PV = ? PMT = $4,000 FV = $0 PV = -$23,701.17
SAL / (1 + r)N = $5,000 / 1.168 = $1,525.13
NAL = $25,000 - $23,701.17 - $1,525.13 = -$226.30
Lake Trolley should borrow and buy.
c. NAL = P - [ (1 - T)(CFt - Et) + TDt ] / [ 1 + (1 - T)r ]t - SAL / (1 + r)N - ITC
(1 - T)(CFt - Et) + TDt = (1 - 0.00)($5,000 - $0) + 0.00 x ($25,000 - $5,000) / 8
(1 - T)(CFt - Et) + TDt = $5,000
1 + (1 - T)r = 1 + (1 - 0.00) x 12% = 1.12
$5,000 / 1.12: n = 8 r = 12% PV = ? PMT = $5,000 FV = $0 PV = -$24,838.20
SAL / (1 + r)N = $5,000 / 1.208 = $1,162.84
NAL = $25,000 - $24,838.20 - $1,162.84 = -$1,001.04
Lake Trolley should borrow and buy.
d. If the residual value at the end of 8 years is only $500, Lake Trolley will realize a loss of $5,000 - $500 = $4,500
which will generate a tax credit of 0.40 x $4,500 = $1,800. So, instead of foregoing $5,000, the trolley company
foregoes $500 + $1,800 = $2,300.
The NAL will increase by ($5,000 - $2,300)/1.168 = $823.57 to $597.27
Lake Trolley should lease.
If Lake Trolleys tax rate is 0%, it will only forego $500.
The NAL will increase by ($5,000 - $500)/1.208 = $1,046.56 to $45.52
Lake Trolley should lease.
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CORPORATE FINANCIAL MANAGEMENT, Fourth Edition

B11. a.

Solutions Manual, Chapter 21

The lease payments and depreciation tax credits, and resulting net cash flows (excluding the residual value)
are summarized in the table below:
Year
1
2
3
4
5
6
7
8
9
10

Lt
1000
1000
1000
1000
1000
2000
2000
2000
2000
2000

(1-T)Lt
600
600
600
600
600
1200
1200
1200
1200
1200

Dt
2000
1750
1500
1250
1000
400
400
400
400
400

TDt
800
700
600
500
400
160
160
160
160
160

CFATt
1400
1300
1200
1100
1000
1360
1360
1360
1360
1360

10

500,000
CFAT t
t
[1.15 ]10
t =1 [1 + (1 - 0.4)(0.125 ) ]

NAL = 10,000,000 -

= 10,000,000 - 8,746,197 - 123,592 = $1,130,211

b.

If the firm is unable to claim the tax credits in years 1 through 3, it loses the opportunity to claim tax
deductions of $400 per year on the $1,000 lease payments and also loses the depreciation tax credits of
$800, $700, and $600 in years 1 through 3, respectively. The total tax loss carryforward is $3300 (= 3
(400) + 800 + 700 + 600), which will be claimed in year 4. The net cash flows (excluding the residual
value) will be as follows:
Year
1
2
3
4
5
6
7
8
9
10

Lt
1000
1000
1000
1000
1000
2000
2000
2000
2000
2000

(1-T)Lt
1000
1000
1000
600
600
1200
1200
1200
1200
1200

Dt
2000
1750
1500
1250
1000
400
400
400
400
400

TDt
0
0
0
500
400
160
160
160
160
160

CFATt
1000
1000
1000
-2200
1000
1360
1360
1360
1360
1360

The net advantage to leasing is:

10

NAL = 10,000,000 -

500,000
CFAT t
t=1 [1 + (1 - 0.4)(0.125) ]t [1.15 ]10

= $10,000,000 - 5,482,470 - 123,592 = $4,393,938

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CORPORATE FINANCIAL MANAGEMENT, Fourth Edition

Solutions Manual, Chapter 21

B12. a. r = (0.8333)10% + (0.16667)12% = 10.3333%

D = ($5,000,000 - $250,000) / 6 = $791,666.67
$5,000,000 - $250,000 / 1.156 = $4,891,918.10
n = 6 r = (1-0.4)10.333% PV = -$4,891,918.10 PMT = ? FV = 0 PMT = $1,001,087
$1,001,087 = (1-0.4)Lease - (0.4)791,666.67; so that Lease payment = $1,140,700
b. r = 0.8333 x 10% x (1 - 0.30) + 0.1667 x 12% x (1 - 0.30) = 7.2333%
NAL = $5,000,000 - [(1 - 0.30) x $1,140,700 + 0.30 x ($791,666.67)] / 1.0723n $250,000 / 1.156
CALC: n = 6 r = 7.2333% PV = ? PMT = $1,035,990 FV = 0 PV = -$4,902,717.40
NAL = $5,000,000 - $4,902,717.40 - $108,081.90
NAL = -$10,799.30
c. $4,891,918.10 = [(1 - 0.30) x PMT + 0.30 x $791,666.67] / 1.0723 n
CALC: n = 6 r = 7.2333% PV = -$4,891,918.10 PMT = ? FV = 0 PMT = $1,033,708
0.70 x PMT + 0.30 x $791,666.67 = $1,033,708
PMT = $1,137,440
d. Because Amalgamateds break-even lease payment exceeds Sandovals, it is not possible to find a
beneficial lease rate.

mutually

B13. a. CF0 = 125 CF1 = -10.5 CF2 = -12 CF3 = -14.5 CF4 = -16.5 CF5 = -19.5 CF6 = -22.5
CF7 = -112.5 IRR = 9.86%
b. Yes.
B14. a.
Year
0
1
2
3
4
Outlay
$100,000
$0
$0
$0
$0
Payment
-$16,000 -$16,000 -$16,000 -$16,000 -$16,000
Tax Credit
$6,400 $6,400 $6,400 $6,400 $6,400
Dep Tax Credit
$0 -$5,000 -$5,000 -$5,000 -$5,000
Salvage
$0
$0
$0
$0
$0
Net CF
$90,400 -$14,600 -$14,600 -$14,600 -$14,600
PV CF
$90,400 -$13,931 -$13,293 -$12,684 -$12,103
NAL
-$1,432

5
$0
-$16,000
$6,400
-$5,000
$0
-$14,600
-$11,549

6
$0
-$16,000
$6,400
-$5,000
$0
-$14,600
-$11,020

7
$0
-$16,000
$6,400
-$5,000
$0
-$14,600
-$10,515

8
$0
$0
$0
-$5,000
-$4,800
-$9,800
-$6,735

b.
Year
0
1
2
3
4
5
6
7
8
Outlay
$100,000
$0
$0
$0
$0
$0
$0
$0
$0
Payment
-$16,000 -$16,000 -$16,000 -$16,000 -$16,000 -$16,000 -$16,000 -$16,000
$0
Tax Credit
$6,400 $6,400 $6,400 $6,400 $6,400
$6,400 $6,400 $6,400
$0
Dep Tax Credit
$0 -$8,000 -$12,800 -$7,680 -$4,608 -$4,608 -$2,304
$0
$0
Salvage
$0
$0
$0
$0
$0
$0
$0
$0 -$4,800
Net CF
$90,400 -$17,600 -$22,400 -$17,280 -$14,208 -$14,208 -$11,904 -$9,600 -$4,800
PV CF
$90,400 -$16,794 -$20,395 -$15,013 -$11,778 -$11,239 -$8,985 -$6,914 -$3,299
NAL
-$4,017
The answers differ because the present value of the depreciation tax shield is different.
c.
Year
0
1
2
3
4
5
6
7
8
Outlay
$100,000
$0
$0
$0
$0
$0
$0
$0
$0
Payment
-$15,019 -$15,019 -$15,019 -$15,019 -$15,019 -$15,019 -$15,019 -$15,019
$0
Tax Credit
$6,008 $6,008 $6,008 $6,008 $6,008
$6,008 $6,008 $6,008
$0
Dep Tax Credit
$0 -$8,000 -$12,800 -$7,680 -$4,608 -$4,608 -$2,304
$0
$0
Salvage
$0
$0
$0
$0
$0
$0
$0
$0 -$4,800
Net CF
$90,988 -$17,012 -$21,812 -$16,692 -$13,620 -$13,620 -$11,316 -$9,012 -$4,800
PV CF
$90,988 -$16,233 -$19,859 -$14,502 -$11,291 -$10,774 -$8,541 -$6,490 -$3,299
NAL
$0
Use Excels Goal Seek function under the Tools menu to set NAL equal to zero by changing the payment.
B15.
Copyright 2011 by Wohl Publishing, Inc. All rights reserved.

Page 7 of 10

CORPORATE FINANCIAL MANAGEMENT, Fourth Edition

Year
Outlay
Payment
Tax Credit
Dep Tax Credit
Salvage
Net CF
PV CF
NAL

0
$3,000,000
-$550,000
$165,000
$0
$0
$2,615,000
$2,615,000
$212,582

1
$0
-$550,000
$165,000
-$299,970
$0
-$684,970
-$644,374

2
$0
-$550,000
$165,000
-$400,050
$0
-$785,050
-$694,754

Solutions Manual, Chapter 21

3
$0
-$550,000
$165,000
-$133,290
$0
-$518,290
-$431,492

4
5
$0
$0
-$550,000
$0
$165,000
$0
-$66,690
$0
$0 -$490,000
-$451,690 -$490,000
-$353,759 -$278,039

Problem Set C
C1. This problem is referenced as a break-even lease payment, but the problem asks for the break-even tax rate. The breakeven lease rate is $5168.00 (see below).
If the trolleys depreciation is to $5,000, there is no break-even tax rate because with a tax rate of zero, NAL equals
$9.29.
If the trolleys depreciation is to $500, the break-even tax rate equals 1.188%, which is the tax rate where NAL equals
$0.00.
Year
0
1
2
3
4
5
Outlay
$25,000.00
Payment
-$5,168.00 -$5,168.00 -$5,168.00 -$5,168.00 -$5,168.00
Tax Credit
$2,067.20 $2,067.20 $2,067.20 $2,067.20 $2,067.20
Dep Tax Credit
-$1,000.00 -$1,000.00 -$1,000.00 -$1,000.00 -$1,000.00
Net CF
$25,000.00 -$4,100.80 -$4,100.80 -$4,100.80 -$4,100.80 -$4,100.80
PV CF
$25,000.00 -$3,825.37 -$3,568.45 -$3,328.77 -$3,105.20 -$2,896.64
Salvage
Dep Tax Credit
PV Salvage
NAL
$0.00
T
40%

-$5,168.00
$2,067.20
-$1,000.00
-$4,100.80
-$2,702.09

-$5,168.00
$2,067.20
-$1,000.00
-$4,100.80
-$2,520.61

-$5,168.00
$2,067.20
-$1,000.00
-$4,100.80
-$2,351.31
-$500.00
-$1,800.00
-$701.56

Solve for the break-even lease payment using Excels Goal Seek function by setting the NAL equal to zero by changing
the year one lease payment. The net cash flow must be a function of the lease payment and each lease payment must be
a function of the first lease payment.

Copyright 2011 by Wohl Publishing, Inc. All rights reserved.

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CORPORATE FINANCIAL MANAGEMENT, Fourth Edition

C2.

Solutions Manual, Chapter 21

a.

A lease represents a form of secured debt. Each lease payment includes an interest component and a
principal repayment component. Because the lease payment is taxable as ordinary income to the lessor, in
effect, the entire debt service stream (i.e., the interest component and the principal component) is taxable as
ordinary income.

b.

The following condition must hold:

PV(lessee's lease payment tax shields) + PV(lessor's depreciation tax shields + other tax credits)
<is greater than>
PV(lessor's lease payment tax liability) + PV(lessee's depreciation tax shields + other tax
credits)
in order for a financial lease transaction to generate positive net present value
benefits for lessor and
lessee combined.

c.

Each after-tax lease payment is $1,047,000 (= 1,745,000 - 698,000). The net advantage to leasing for
NACCO must decrease because the lease payments are accelerated by 1 year:

1,047,000
NAL = 10,000,000 -
t
t = 0 [1 + (1 - 0.4) _ 0.12 ]

10

380,000
500,000
t=1 [1 + (1 - 0.4) _ 0.12 ]t [1 + 0.15 ]10

= 10,000,000 - 7,810,789 - 2,644,460 - 123,592 = - $578,841

which is more than $500,000 lower than the net advantage to leasing calculated in the text, which was $54,236.
d.

If NACC) is nontaxable, its net advantage to leasing is:

1,745,000 500,000
NAL = 10,000,000 -
= - $1,142,472
t
10
(1.175 )
t = 0 (1.12 )
The net advantage of the lease to the lessor is:

1,047,000 10 380,000 500,000

NPVL = -10,000,000 + t + t + 10 = $578,841
t =0 (1.072 ) t =1 (1.072 ) (1.15 )
which is smaller than NAL in absolute value.
e.

A mutually advantageous lease rate, L, must satisfy the following two conditions simultaneously:

Copyright 2011 by Wohl Publishing, Inc. All rights reserved.

Page 9 of 10

CORPORATE FINANCIAL MANAGEMENT, Fourth Edition

Solutions Manual, Chapter 21

500,000
L
> 0 implies L < 1,564,465
t
10
t = 0 (1.12 ) (1.175 )

NAL = 10,000,000 -
9

0.6 _L 10 380,000 500,000

NPVL = - 10,000,000 +
+
+
> 0 implies L > 1,615,681
t
t
t
(1.072
(1.072
(1.15
)
)
)
t =0
t =1
The two conditions cannot be satisfied simultaneously; a mutually beneficial lease rate therefore does not
exist.
f.

Making the lease payments in advance imposes a net tax cost when the lessor pays income tax at a higher
rate than the lessee.

Copyright 2011 by Wohl Publishing, Inc. All rights reserved.

Page 10 of 10