Question
CanAir has decided to acquire new jets for its airline operations. The jets have an initial purchase price of $100 million per jet. Management is
CanAir has decided to acquire new jets for its airline operations. The jets have an initial purchase price of $100 million per jet. Management is now considering 2 choices: purchase or lease these jets.
Purchase optionCanAir would finance the purchase with a bank term loan at a stated interest rate of 8% over a period of 10 years. The salvage value of each jet after 10 years is expected to be $10 million. CanAir will incur pre-tax maintenance costs of $2 million per jet per year. These operating costs are incurred at the end of the year and are for the purchase option only.
Lease optionThe lease provided by the finance and leasing subsidiary of the jet manufacturer will require payments of $13 million per year for 10 years, to be paid at the beginning of each year (the first payment will be made at the time the lease contract is signed), while operating cash flows and the tax payments will occur at the end of each year. The maintenance costs are included in the lease contract.
CanAir has a corporate tax rate of 20%. The CCA rate for the jets is 25%. Determine whether CanAir should purchase or lease the jets based on a lease vs. buy evaluation for a single jet.
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