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Ladybug Inc. is considering a leasing arrangement to finance some construction equipment that it needs for the next three years. The equipment will be obsolete and worthless after 3 years. The firm will depreciate the cost of the equipment at a CCA rate of 20%. It can borrow $4,800,000, the purchase price, at 10% per year and buy the equipment, or it can make 3 equal end-of-the-year payments of $2,300,000 each and lease the equipment. The loan obtained from the bank is a 3-year simple interest loan, with interest paid at the end of the year. Ladybug's tax rate is 40%. Annual maintenance and insurance costs associated with ownership are estimated at $240,000, but these costs would be borne by the lessor if Ladybug leases. A) What would you recommend Ladybug to do, borrow to buy lease? B) The lessor, Caterpillar Inc. has a tax rate of 50% and its pre-tax rate of return is 8%. At an annual receipt of $2,300,000, is Caterpillar Inc. willing to invest and lease the equipment to Ladybug? How much would the minimum annual lease payment/receipt on a pre-tax basis be so that Caterpillar is willing to invest and lease? C) Briefly explain how come both a lessee and a lessor may benefit from a lease transaction financially (be sure to discuss what the financial benefits are specific to a lessee and a lessor). Who may be the losing third party in a lease transaction? Ladybug Inc. is considering a leasing arrangement to finance some construction equipment that it needs for the next three years. The equipment will be obsolete and worthless after 3 years. The firm will depreciate the cost of the equipment at a CCA rate of 20%. It can borrow $4,800,000, the purchase price, at 10% per year and buy the equipment, or it can make 3 equal end-of-the-year payments of $2,300,000 each and lease the equipment. The loan obtained from the bank is a 3-year simple interest loan, with interest paid at the end of the year. Ladybug's tax rate is 40%. Annual maintenance and insurance costs associated with ownership are estimated at $240,000, but these costs would be borne by the lessor if Ladybug leases. A) What would you recommend Ladybug to do, borrow to buy lease? B) The lessor, Caterpillar Inc. has a tax rate of 50% and its pre-tax rate of return is 8%. At an annual receipt of $2,300,000, is Caterpillar Inc. willing to invest and lease the equipment to Ladybug? How much would the minimum annual lease payment/receipt on a pre-tax basis be so that Caterpillar is willing to invest and lease? C) Briefly explain how come both a lessee and a lessor may benefit from a lease transaction financially (be sure to discuss what the financial benefits are specific to a lessee and a lessor). Who may be the losing third party in a lease transaction
