08 May WHAT IS THE GAIN TO AMAZON WITH THIS LEASE RATE?
(1) Suppose Procter and Gamble (P&G) is considering purchasing $10 million in new manufacturingequipment. If it purchases the equipment it will depreciate it on a straight-line basis over thefive years after which the equipment will be worthless. It will also be responsible formaintenance expenses of $1.75 million per year. Alternatively it can lease the equipmentfor$2.3 million per year for the five years in which case the lessor will provide necessarymaintenance. Assume P&G?s tax rate is 30% and its borrowing cost is 6.0%.a. What is the NPV associated with leasing the equipment versus financing it with the leaseequivalent loan?b. What is the break-even lease rate—that is what lease amount could P&G pay each year and be indifferent between leasing and financing a purchase? (2)Suppose Amazon is considering the purchase of computer servers and network infrastructure toexpand its very successful business offering cloud-based computing. In total it will purchase$48.6 million in new equipment. This equipment will qualify for accelerated depreciation: 20?n be expensed immediately followed by 32% 19.2% 11.52% 11.52% and 5.76% over thenext five years. However because of the firm’s substantial loss carryforwards and other credits Amazon estimates its marginal tax rate to be 10% over the next five years so it will get very littletax benefit from the depreciation expenses. Thus Amazon considers leasing the equipmentinstead. Suppose Amazon and the lessor face the same 8.2% borrowing rate but the lessor hasa 35% tax rate. For the purpose of this question assume the equipment is worthless after fiveyears the lease term is five years and the lease qualifies as a true tax lease.a. What is the lease rate for which the lessor will break even?b. What is the gain to Amazon with this lease rate?c. What is the source of the gain in this transaction?
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