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) S345 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) S345 C) $78 D) -$18 E) -$142

I NEED STEP BY STEP SOLUTION PLEASE AND THANK YOU

Answer 1

Solution: Post tax cost to debt: Post tax cost 8%"(1-0.3-5.6% NPV Cost to buy: Working Note Tax saving on tax depriciation allowance Tax written down value Tax saving at 30% Timing USD Initial cost Year 1 : 30% 240 72 168 50.4 21.6 End of Year 1 Year 2 : 30% 15.12 End of Year 2 Year 3 : 30% 10.58 End of Year 3 35.28 82.32 82.32 0 Year 4 : 30% 24.7 End of Year 4

Working two - Cash flow table for asset purchase Start End of year 1 End of year 2 End of yeaEnd of year 4 USD Initial cost Tax saving (240) 21.6 15.1210.58 24.7 Net cash flows 5.6% Discount factors Present values Net Present Value (240) 1 (240) 21.6 0.947 20.5 15.1210.58 24.7 0.804 20 176.8 0.897 0.849 13.7

NPV cost to lease: Working note - Three- NPV using the sum of digit Approach $70,000 Yearly installment- 4 Years installment Interest implict = $70,000 * 4 = $280,000 $280,000-$240,000 $40,000 Sum of digit formula- n =4 (4 * (4+1))/2 = 10 nterest allowable can be allowable for each year can be calculated as follows Year 1 Year 2 Year 1 Year 1 $40,000*4/10 $16,000 $40,000*3/10 $12,000 $40,000*2/10 $8,000 $40,000 1/10 $4,000 thenth and in the fist year we take 4/10 as we want to spread the interest over four years. The numerator then declines each year Tax relief calculation Year 1 Year 2 16 year 3 12 60 72 Year 4 USD Allowable interest Allowable depriciatio 240/4 Total tax allowable cost Tax savings at 30% Receiveable at the end of vear 4 76 23 1 64 19.2 4 20.4 2

Npv of cost of calculation End of year 1 0 End of year 2 End of yee End of year 4 USD Lease charge tax savinf B/f Start (70) 23 (70) (70) 20.4 (70) 19.2 net cash flows 5.6 % Discount factor Present value Net Present value 0 1 0 -47 0.947 -44.5 -48 0.897 -43 50 0.849 -42 51 0.804 -41 -170.5 Approximately $18 is advantage - Option -D