Question
Blow Finance Ltd (BFL) will acquire a fleet of 8 cars to use for five years. Each car costs $ 2.5 million. Blow Finance Ltd
Blow Finance Ltd (BFL) will acquire a fleet of 8 cars to use for five years. Each car costs $ 2.5 million. Blow Finance Ltd faces a 15% tax and has two alternatives regarding financing: Option I: Blow Finance Ltd can borrow the funds at 10 % (after tax) and buy the fleet. If it borrows, it will pay only interest each year and repay all the principal in five years. Blow Finance Ltd will depreciate the cars over five years, on a straight line basis. Option II: Blow Finance Ltd can lease the entire fleet for $ 15 million per year. Should Blow Finance Ltd buy or lease the fleet? Show all intermediate steps and workings. You must use the following figures which give the present value of $1 at 10%. Year 10% 1 0.9091 2 0.8264 3 0.7513 4 0.6830 5 0.6209
Hint:
1. Identify the after-tax cash flows;
2. Determine NPV of cash flows under each alternative;
3. Calculate the net advantage of leasing (NAL) and decide.
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