Craxton Engineering will either purchase or lease a new 7520

Craxton Engineering will either purchase or lease a new $752,000 fabricator. If? purchased, the fabricator will be depreciated for tax purposes on a? straight-line basis over seven years. Craxton can lease the fabricator for$130,000 per year for seven years.? Craxton\'s tax rate is 36%.?(Assume the fabricator has no residual value at the end of the seven? years.)

a. What are the free cash flow consequences of buying the? fabricator?

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

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

Solution

a). Capital Expenditure = FCF₀ = $752,000

Depreciation Tax Shield = FCF_1-7 = 36% x $752,000/7 = 36% x $107,428.57 = $38,674.29

b). After-tax lease payment = FCF_0-6 = $130,000 x (1 - 36%) = $83,200

c). FCF₀ = -$83,200 - (-$752,000) = $668,800

FCF_1-6 = -$83,200 - $38,674.29 = -$121,874.29

  FCF₇ = 0 - $38,674.29 = -$38,674.29