Magna Charter has been asked to operate a Beaver bush plane for a mining company exploring in Yukon. Magna will have a 1-year contract with the mining company and expects that the contract will be renewed after 1 year, for the remaining 4 years of the exploration program. If the mining company renews after 1 year, it will commit to use the plane for 4 more years.

Magna Charter has the following choices:

Buy the plane for $500,000

Arrange a 5-year, non-cancellable, net financial lease at a rate of $75,000 per year, paid in advance

How would you advise Agnes Magna, the charter company's CEO? Assume that the CCA rate is 25% and Magna has many other airplanes in its asset pool. The first CCA deduction is made at the end of the first year. The company's tax rate is 35%. The weighted-average cost of capital for the bush plane business is 14%, but Magna can borrow at 9%.

Ms. Magna thinks the plane will be worth $300,000 after 5 years. She also thinks that there is a 20% chance that the contract will not be renewed at year 1. If the contract is not renewed, the plane will have to be sold on short notice for $400,000.

If Magna Charters takes the 5-year financial lease and the mining company cancels at year 1, Magna can sublet the plane, that is, rent it out to another user. Magna must cover the operating costs of the plane. Assume that the operating costs are identical whether Magna buys or leases the plane