Question
Prairie Shipping Corporation (PSC) is planning to buy a truck at a cost of $140,000. The company needs the truck for 5 years. The truck
- Prairie Shipping Corporation (PSC) is planning to buy a truck at a cost of $140,000. The company needs the truck for 5 years. The truck qualifies for a 20% CCA rate. PSC has a tax rate of 20% and it can borrow at 8%. Lora, the financial manager, approaches Capital Leasing Inc (CLI). CLI offers to lease the truck to PSC at $32,000 per year to be paid at the beginning of the year.
- Assume that the tax breaks from the CCA are realized at the end of the year and that the undepreciated capital cost (UCC) remaining after Year 5 is realized as loss at the end of Year 6 (the asset class is discontinued after Year 5). Calculate the tax breaks that will be lost should PSC decides to lease the truck. (6 marks).
Use the following table or a similar one to answer Part (a): (1 mark per correct number per year)
Loss of tax breaks on the CCA | |||||||
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- Assume that the lease payments are paid at the beginning of the year but the tax breaks from the lease payments are realized at the end of the year in which they are paid. You want to calculate the Net Advantage to Leasing (NAL) for PSC. What are the incremental cash flows for this calculation? (6 marks).
Use the following table or a similar one to answer Part (b): (1 mark per correct number per year)
Incremental cash flows for NAL calculations | |||||||
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- What is the NAL for PSC? (4 marks)
- Assume that the asset class will be continued at the end of Year 6 and that the UCC will continue for a long time. Also assume that the tax breaks from the lease payments are realized at the end of the year in which they are paid. What are the incremental cash flows for this scenario? (3 marks) Hint: The incremental cash flows for this scenario exclude the loss of tax breaks on the CCA because the present value of the tax breaks will be calculated separately. (1 mark per correct number per year)
Incremental cash flows for NAL calculations | |||||||
End of Year | 0 | 1 | 2 | 3 | 4 | 5 | 6 |
Initial cash flows | 120000 | ||||||
Lease payments | -28000 | -28000 | -28000 | -28000 | -28000 | ||
Tax breaks on lease payments | 5600 | 5600 | 5600 | 5600 | 5600 | ||
Incremental cash | 92,000 | -22,400 | -22,400 | -22,400 | -22,400 | 5600 | 0 |
- Assume that the asset class will not be discontinued at the end of Year 6 and that the UCC will continue for a long time. Also assume that the tax breaks from the lease payments are realized at the end of the year in which they are paid. What is the NAL for PSC under this scenario? (6 marks)
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