Problem 1:

Magna Charter has been asked to operate a Beaver bush plane for a mining company exploring in Yukon. Magna will have a 5-year contract with the mining company. The mining company will commit to use the plane for 5 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 companys 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 companys 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.

If Magna Charters takes the 5-year financial lease. Magna must cover the operating costs of the plane. Assume that the operating costs are identical whether Magna buys or leases the plane.