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The Tax Cash Flows of Lease Payments - Case Study Example

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The paper "The Tax Cash Flows of Lease Payments" describes that Hasbro would base two factors to determine their decision of whether or not to buy the machinery. The first factor is whether the “wear and tear” level of the machinery is more than or less than it should be as a five-year-old one…

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Extract of sample "The Tax Cash Flows of Lease Payments"

The after-tax cash flows associated with the lease payments equal the sum of rental fees over the next five years and the after-tax cash flow of purchasing the machinery for $6,000. Therefore, the after-tax cash flows are equal to ($7,000 × 5 + $6000) × (1 - 40%) = $24,600.

1st year: $2,400 × (1 – 40%) = $1,440; 2nd year: $1,991 × (1 – 40%) = $1,194;

3rd year: $1,549 × (1 – 40%) = $929; 4th year: $1,072 × (1 – 40%) = $643;

5th year: $556 × (1 – 40%) = $334.

The depreciation expenses are:

1st year: $30,000 × 20% = $6,000; 2nd year: ($30,000 - $6,000) × 32% = $7,680;

3rd year: ($30,000 - $6,000 - $7,680) × 19% = $3,101;

4th year: ($30,000 - $6,000 - $7,680 - $3,101) × 12% = $1,586;

5th year: ($30,000 - $6,000 - $7,680 - $3,101 - $1,586) × 12% = $1,396.

Therefore, the depreciation expenses over the five years are $6,000 + $7,680 + $3,101 + $1,586 + $1,396 = $19,763.

The total tax shield is $19,763 + $2,400 + $1,991 + $1,549 + $1,072 + $556 + $1,000 × 5 = $32,331.
The total net after-tax cash outflows associated with purchasing the machinery is ($7,514 + $1,000) × 5 - $32,331 × 40% = $29,638.
Since the present value of the costs associated with leasing (i.e. $24,600) is less than that associated with purchasing (i.e. $29,638), Hasbro should lease the machinery.
The advantage of leasing is that the maintenance costs are borne by the lesser. Therefore, the expenses associated with the machinery leased are predictable, while the maintenance expenses associated with the purchased machinery are unpredictable. Having predictable expenses is an advantage in the financial budgeting of the company. However, the disadvantage to leasing is that, if circumstances dictate that a business must change its operations significantly, it may be expensive or otherwise difficult to terminate a lease before the end of the term. (Wikipedia contributors 2006) For example, if Hasbro finds Maxie a failing project in the middle of the leasing term, it is expensive or difficult for Hasbro to terminate the lease.