1. (II points) Blue Jay Tire (BJT) has decided to proceed with its expansion plans. You have been hired as a consultant to analyze several aspects of its expansion (Case Study Section 3.3). BJT management is considering developing their own capabilities to enter the construction equipment and agricultural tires market. They have asked you to analyze whether BJT should purchase or lease the machines needed. (a) (1 point) (i) Describe two provisions of a lease agreement that create a non-tax lease. (ii) Describe the tax consequences to each of the lessor and lessee of a true tax lease and a non-tax lease. BJT has received two 10-year lease proposals detailed below. Lease Proposal A Lease Proposal B Level Annual Lease Payment $1,750,000 (years 1-5) $2,000,000 (years 6-10) $1,800,000 Annual Maintenance Expense $120,000 $100,000 Savings* Salvage Value $800.000 $500,000 Tax Treatment True Tax True Tax *Realized at the end of the year . BJT will return the machine at the end of the lease. BJT can borrow at 8%. BJT has a 20% tax rate. (b) (2 points) Determine whether BUT should accept lease proposal A or lease proposal B based on expected cost. Show your work.(c) (/ point) Explain two reasons why BJT might choose to lease rather than buy the machine. If BIT proceeds with developing its own capabilities, it forecasts earnings of $35 million per year. In addition, for the next two years, BJT has the option at the beginning of each year to increase production levels at a cost of $4 million. . The probability of a favorable year is 30% for the first year. Conditions in the second year will match the realized conditions of the first year. If BJT decides to increase production levels for year 1: o BJT receives $12 million at the end of the year under favorable conditions. o BJT loses $3 million at the end of the year under unfavorable conditions, and BJT will revert to original production levels for year 2. If BJT decides not to increase production levels for year 1, it can still increase for year 2. . The annual risk-free rate is 3%. (d) (2 points) Calculate the value of BJT's option to defer the production level decision. Show your work. Changes in the political climate have led to the renegotiation of existing global trade agreements. The potential for new agricultural trade agreements creates greater uncertainty for BJT. (e) (/ point) Evaluate qualitatively the impact of ongoing trade renegotiations on the value of BJT's option.As an alternative to developing its own capabilities for specialty tires, BIT is considering the acquisition of True North Tire Company (TNT) (Case Study Section 3.3). If acquired, BJT expects earnings of $36 million per year from TNT. Assume earnings are realized at the end of the year. Assume purchase and acquisition costs are amortized into BJT's earnings estimate. If TNT is acquired, BJT expects to incur $7 million in one-time acquisition related costs. All acquisition costs would be paid using a 90-day bank loan with a $40,000 origination fee, 15% APR (compounded quarterly), and a 5% compensating balance requirement. (f) (2 points) (i) Calculate the effective annual rate (EAR) of the proposed bank loan. Show your work. (ii) Recommend an alternative short-term financing method for BJT. (g) (2 points) Recommend whether BIT should acquire TNT or develop its own capabilities to expand into the construction equipment and agricultural tires market. Justify your recommendation
