PART B – Financial Lease

A company wishes to finance its acquisition of an asset costing $10,000 through a four year lease. The terms of the lease are: 10% per annum effective interest rate, monthly payments in arrears, 40% residual. The corporate tax rate is 40%.

Required:

1. What is the effective price paid for the lease after tax? (Assume that the lessee’s opportunity cost of capital is 14%).

2. What rate of return (IRR) does the lessor earn after tax?

3. Suppose that the lessor wishes to increase its IRR by leverage. It borrows $9,000 of the $10,000 purchase price of the asset (secured against that asset) at 11% effective per annum (what is the nominal rate?). This is an interest only loan with monthly payment in arrears. What is the IRR on this leveraged lease?