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Craxton Engineering will either purchase or lease a new $751,000 fabricator. If? purchased, the fabricator will...

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Craxton Engineering will either purchase or lease a new $751,000fabricator. If? purchased, the fabricator will be depreciated on a?straight-line basis over seven years. Craxton can lease thefabricator for $129, 000 per year for seven years.? Craxton's taxrate is 35%.

?(Assume the fabricator has no residual value at the end of theseven?years.)

a. What are the free cash flow consequences of buying thefabricator if the lease is a true tax? lease?

b. What are the free cash flow consequences of leasing thefabricator if the lease is a true tax? lease?

c. What are the incremental free cash flows of leasing versus?buying?

Answer & Explanation Solved by verified expert
3.6 Ratings (256 Votes)

a ALTERNATIVE 1-PURCHASE
Free Cash Flow:
Cost of Fabricator in year 0 ($751,000)
Depreciation Tax shield:
Annual Depreciation=751000/7= $107,286
Annual Depreciation Tax Shield $37,550 (107286*Tax Rate(35%))
Year 0 1 2 3 4 5 6 7
Free Cash Flow ($751,000) $37,550 $37,550 $37,550 $37,550 $37,550 $37,550 $37,550
b ALTERNATIVE 2-LEASE
Before tax annual cash flow ($129,000)
After Tax Annual Cash Flow=129000*(1-Tax Rate) ($83,850)
Year 0 1 2 3 4 5 6 7
Free Cash Flow $0 -$83,850 -$83,850 -$83,850 -$83,850 -$83,850 -$83,850 -$83,850
c Incremental Free Cash Flow 0 1 2 3 4 5 6 7
($751,000) $121,400 $121,400 $121,400 $121,400 $121,400 $121,400 $121,400

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Transcribed Image Text

Craxton Engineering will either purchase or lease a new $751,000fabricator. If? purchased, the fabricator will be depreciated on a?straight-line basis over seven years. Craxton can lease thefabricator for $129, 000 per year for seven years.? Craxton's taxrate is 35%.?(Assume the fabricator has no residual value at the end of theseven?years.)a. What are the free cash flow consequences of buying thefabricator if the lease is a true tax? lease?b. What are the free cash flow consequences of leasing thefabricator if the lease is a true tax? lease?c. What are the incremental free cash flows of leasing versus?buying?

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