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Taiwan Financial has decided to lease, rather than purchase, a new fleet of fifty golf-cabs

cabs. The current fair market value (FMV) of these cabs today is $100,000 each. They are assumed to have an economic life of three years for both book and tax purposes. Taiwan Financial uses straight-line depreciation for book purposes and MACRS (GDS) rules with the half-year convention for tax purposes. At the end its 3-year life, each cabs estimated FMV will be about 25% of its original price. The leasing company has offered Taiwan Financial a 3-year, non-cancelable lease with an option to purchase the cabs at the end of the lease

term for $10,000 each. Taiwan Financial plans to exercise the purchase option and then keep the cabs indefinitely. Taiwan Financials cost of capital for present value discount purposes is 15% p.a. and its effective corporate income tax rate is 40%.

A.

If the leasing companys before-tax MARR is 10% p.a., what annual lease payment will the lessor charge? Assume, for the purposes of this problem, that lease payments are recognized at the end of each year. Show all work.

B.

Will this lease be treated as an operating lease or as a capitalized lease by Taiwan Financial? Explain.

C.

Construct a table showing all relevant entries on Taiwan Financials balance sheet and income statement for each year of the 3-year lease term. Include only those entries which are affected by the lease.

D.

Construct an after-tax cash flow table for Taiwan Financial for the 3-year term of the lease (assume taxes are paid in the year incurred).

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