[nestle_life]

Hey guys, I don’t remember most of the material in finance from college, so I have a problem understanding this question.

Q) For the next 2 years, a lease is estimated to have an operating net cash inflow of $7,500 per annum, before adjusting for $5K per annum tax basis lease amortization, and a 40% tax rate. The PV of an ordinary annuity for $1 per year at 10% for 2 years is $1.74. What is the lease’s after tax PV using a 10% discount factor?

A) The answer should be: (7,500 * 1.74) – (7500-5000)(40%)(1.74) = $11,310

Me: What I did –>

$7,500 [Cash flow]

5000 * .4 = 2,000 [tax shield]

Total = $9,500

$9,500 * 0.6 = $5,700 [after-tax cash flow] (Am I right here?)

$5,700 * 1.74 = $9,918

I don’t understand why I multiplied 0.6 by the depreciation. What am I not getting right? I’m not having a clear understanding of something, but I can’t pinpoint exactly what the concept is.

[M.O.D.]

You are close.

The two tax flows are from:

cash payments from the lease

7500 less tax of 40% (or x .6) = 4500

4500 x 1.74 = 7830

and from the tax shield for amortization (the basis is given as 5000/year)

2000 x 1.74 = 3480

7830 + 3480 = 11310

BA Mathematics, UC Berkeley
Certificates in CPA and EA preparation, College of San Mateo
CMA I 420, II 470
FAR 91, AUD Feb 2015 (Gleim self-study)

[Author]

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