The Clarkton Company produces industrial machines, which have five-year lives. Clarkton is willing to either sell the machines for $30,000 or lease them at a rental that because of competitive factors yields an after-tax return to Clarkton of 6% (its cost of capital).
A. What is the company’s competitive lease-rental rate? (Assume straight-line depreciation, zero salvage value, and an effective corporate tax rate of 40%.)
B. The Stockton Machine Shop is contemplating the purchase of a machine exactly like those rented by Clarkton. The machine will produce net benefits of $10,000 per year. Stockton can purchase the machine for $30,000 or rent it from Clarkton at the competitive lease-rental rate. Stockton’s cost of capital is 12%, its cost of debt 10%, and T=40%. Which alternative is better for Stockton?
If Clarkton’s cost of capital is 9% and competition exists among lessors, solve for the new equilibrium rental rate. Will Stockton’s decision be altered?