Question

Your firm needs to either buy or lease $240,000 worth of vehicles. These vehicles have a life of 4 years after which time they are worthless. The vehicles belong in CCA class 10 (a 30% class) and can be leased at a cost of $70,000 a year for the 4 years.The lease payments are to be made at the beginning of the year. The corporate tax rate is 30% and the cost of debt is 8%. Assume the half-year rule is in effect.

14.	What is the net advantage to leasing?
	A)	$1,109
	B)	$345
	C)	$78
	D)	-$18
	E)	-$142

15.	The lessor in this case has a tax rate of 40% and a cost of debt equal to 7%. What is the net advantage of leasing to the lessor?
	A)	$626
	B)	$345
	C)	$78
	D)	-$18
	E)	-$142

16.	What is the amount of the break-even lease payment to the lessor?
	A)	$47,740
	B)	$51,254
	C)	$63,334
	D)	$69,723
	E)	$74,421

Answer 1

Present value of CCA = (240000 * 30% * (tax rate) /(30% + .08(1-tax rate)) ) * (1 + .5*.08*(1-tax rate))/(1+ .08*(1- tax rate) )

= 59065

NPV of buying = 240000 - 59065 = -$180935

NPV of leasing = 70000* (1-t) + 70000 * (1 - t) /(1.056) + 70000* (1-t)/(1.056)^2 + 70000* (1 - t)/ (1.056)^3

= -$180953

Net Advantage to leasing = NPV of leasing - NPV of buying = -$18

Ans 15) We will use above method but tax rate will be changed to 40% and cost of debt is equal to 7%

NPV of buying = - $157487

NPV of leasing = 70000*.6 + 70000*.6/(1.042) + 70000*.6/1.042^2 + 70000*.6/1.042^3

= -$158113

Net advantage of leasing to lessor = 158113 - 157487 = $626

Ans 16) For break even point buying will be equal to leasing

157487 = x*.6 + x*.6/(1.042) + x*.6/(1.042)^2 + x*.6/(1.042)^3

x = 157487/2.25875432 = $69723