Comey Products has decided to acquire some new equipment having a $230,000 purchase price. The equipment will last 4 years and is in the MACRS 3-year class. (The depreciation rates for Year 1 through Year 4 are equal to 0.3333, 0.4445, 0.1481, and 0.0741.) The firm can borrow at a 10% rate and pays a 25% federal-plus-state tax rate. Comey is considering leasing the property but wishes to know the cost of borrowing that it should use when comparing purchasing to leasing and has hired you to answer this question. What is the correct answer to Comey’s question? (Hint: Use the shortcut method to find the after-tax cost of the loan payments.) Do not round intermediate calculations. Round your answer to the nearest dollar.

To answer Comey's question about the cost of borrowing for comparing purchasing to leasing, we need to calculate the **after-tax cost of the loan payments**. Using the shortcut method, this can be done as follows:

### Step 1: Calculate the loan's annual interest payment
The firm is borrowing to purchase the equipment at a 10% interest rate. The total purchase price of the equipment is \$230,000. 

The annual interest expense is:
\[
\text{Interest Payment} = \text{Loan Amount} \times \text{Interest Rate}
\]
\[
\text{Interest Payment} = 230,000 \times 0.10 = 23,000
\]

### Step 2: Calculate the after-tax interest cost
Since the firm pays taxes at a 25% rate, it can deduct the interest expense from its taxable income, reducing the actual cost of the loan. The after-tax cost of the interest is calculated by subtracting the tax savings from the interest payment.

\[
\text{After-Tax Interest Cost} = \text{Interest Payment} \times (1 - \text{Tax Rate})
\]
\[
\text{After-Tax Interest Cost} = 23,000 \times (1 - 0.25) = 23,000 \times 0.75 = 17,250
\]

### Step 3: Find the after-tax cost of loan payments
The after-tax cost of the loan payments is simply the **after-tax interest cost**, since the question is asking for the after-tax cost of borrowing, not the full cost including principal repayment.

\[
\text{After-Tax Cost of Loan Payments} = 17,250
\]

Thus, the correct after-tax cost of loan payments that Comey should use when comparing purchasing to leasing is **\$17,250**.

Would you like more details or have any questions?

---

### 5 Related Questions:
1. How would changing the tax rate affect the after-tax cost of loan payments?
2. What is the impact of different depreciation schedules on the decision to lease or purchase?
3. How do MACRS depreciation rates affect the total tax savings over the life of the equipment?
4. How does the cost of borrowing compare to the cost of leasing in the long term?
5. What are the potential financial benefits of leasing instead of buying equipment?

### Tip:
Always account for tax savings from interest expenses when calculating the after-tax cost of borrowing. It can significantly reduce the effective cost.

Calculate the after-tax cost of loan payments for Comey Products' equipment purchase, considering a $230,000 price, 10% loan interest, and a 25% tax rate. Learn how to use the shortcut method for financial decision-making when comparing leasing and buying.

Math Problem Statement

Solution

Ask a new question for Free

By Image

Math Problem Analysis

Mathematical Concepts

Formulas

Theorems

Suitable Grade Level

Related Recommendation