Question 18.5: Your company is looking at leasing office space for the next...
Your company is looking at leasing office space for the next three years and has identified two options. The first option is to lease space for $13,200 per year. The second option is to lease space for $10,800 per year; however, the second option will require you to spend $10,000 during the first year to comply with the Americans with Disability Act. Your company can claim a tax credit equal to 50% of the costs of the modifications made to comply with the Americans with Disability Act. Both leases may be treated as an operating lease. Using a MARR of 15% and a marginal tax rate of 35%, determine the before-tax and after-tax net present values (costs) for both options. How do taxes affect your decision?
Determine the before-tax net present cost for the first option using Eq. (15-3) as follows:
P = F/(1 + i)^n (15-3)
NPV = (-$13,200)/1.15^1 + (-$13,200)/1.15^2 + (-$13,200)/1.15^3
NPV = -$30,139
The cash flow for the first year of the second option is a cash disbursement of $20,800 ($10,800 + $10,000). Determine the before-tax net present cost for the second option using Eq. (15-3) as follows:
NPV = (-$20,800)/1.15^1 + (-$10,800)/1.15^2 + (-$10,800)/1.15^3
NPV = -$33,354
Based on the before-tax net present cost the first option is more attractive. The annual tax savings and the after-tax cash flow for the first option is as follows:
Tax_{1-3} = $13,200(0.35) = $4,620
Cash Flow_{1-3} = -$13,200 + $4,620 = -$8,580
The after-tax net present cost for the first option is calculated using Eq. (15-3) as follows:
NPV = (-$8,580)/1.15^1 + (-$8,580)/1.15^2 + (-$8,580)/1.15^3
NPV = -$19,590
The annual tax savings for the second option are as follows:
Tax_1 = $20,800(0.35) + $10,000(0.50) = $12,280
Tax_{2-3} = $10,800(0.35) = $3,780
The after-tax cash flows for the second option are as follows:
Cash Flow_1 = -$20,800 + $12,280 = -$8,520
Cash Flow_{2-3} = -$10,800 + $3,780 = -$7,020
The after-tax net present cost for the second option is calculated using Eq. (15-3) as follows:
NPV = (-$8,520)/1.15^1 + (-$7,020)/1.15^2 + (-$7,020)/1.15^3
NPV = -$17,333
Based on the after-tax net present cost the second option is more attractive. The most financially attractive alternative changes from the first alternative to the second alternative after taxes are included in our analysis because the second alternative gets a $5,000 tax credit.