I am in need of some major help.
Your small business needs to buy new office furniture for your new headquarters. You have the option of leasing the furniture, or buying the furniture. You can purchase the furniture for $15,000 per year, or lease the same furniture for $5,000 per year for the next four years.
Your company has a marginal tax rate of 40%. Depreciation will amount to $3,750 per year and the furniture will be replaced after 4 years. If your company buys the furniture, they will borrow at 7%.
Required:
1.Calculate the total cost for both options.
2.Leasing vs. buying: which is the best option for your small business and why?
I don't where to start to complete this. Please help me. Thanks in advance.
To calculate the total cost for both options, we need to consider the expenses associated with each option. Here's how you can calculate it:
Option 1: Buying the furniture
- The purchase cost is $15,000 per year, and it will be replaced after 4 years. Therefore, the total purchase cost for 4 years is $15,000 x 4 = $60,000.
- However, we need to consider the tax benefits of depreciation. The depreciation amount is $3,750 per year, so over 4 years it amounts to $3,750 x 4 = $15,000. Since the company's marginal tax rate is 40%, the tax saving due to depreciation is $15,000 x 0.4 = $6,000.
- The net cost of buying the furniture is the total purchase cost minus the tax saving: $60,000 - $6,000 = $54,000.
Option 2: Leasing the furniture
- The lease cost is $5,000 per year for 4 years. Therefore, the total lease cost for 4 years is $5,000 x 4 = $20,000.
Now let's compare both options to determine which one is more beneficial for your small business:
Option 1: Buying the furniture
- Total cost: $54,000 (as calculated above)
Option 2: Leasing the furniture
- Total cost: $20,000 (as calculated above)
Based on the calculations, the total cost of leasing the furniture is significantly lower than the cost of buying it. Therefore, leasing is the better option in terms of cost for your small business.