Question

A new robotic welder can be leased for 5 years with annual payments of $300,000 with the first payment occurring at lease inception. the system would cost $1,050,000 to buy and would be depreciated straight-line to a zero salvage value. the actual salvage value is zero. the firm can borrow at 8 percent and has a tax rate of 34 percent. what discount rate should be used for valuing the lease? 2.72% 5.28% 8.00% 12.12% 10.72%

Answer 1

Answer:

Option B. 5.28%

Explanation:

The cost of unquoted debt can be found from the following formula:

Cost of Debt = Interest rate * (1 - Tax rate)

The interest rate here is 8% and tax rate is 34%.

So by putting the values we have:

Cost of Debt = 8% * (1 - 34%) = 5.28%

So the cost of debt to the company is 5.28% and rate of return for appraising this opportunity as well.

Answer 2

Answer:

5.28%

Explanation:

the actual after tax rate paid by the company = interest rate x (1 - tax rate) = 8% x (1 - 34%) = 8% x .66 = 5.28%

When a company borrows money, the principal it pays back is not tax deductible, but the interest paid is tax deductible. Therefore, the real cost of borrowing money for a company is the actual interest times 1 - tax rate, since all interest paid will be deducted.