Ques. 36

Ladybug Inc. wants to enter into a leasing arrangement to help finance some construction equipment it needs for the next three years.

The equipment will hold NO value after the three years, as the firm will depreciate the cost of it at a CCA rate of 20%

So Ladybug Inc. could borrow $4.0 million (the purchase price) at 10%/year interest, PLUS buy the equipment. OR it can make three equal annual (end of the year) payments of $2.3 million each and LEASE the equipment.

The loan from the bank is a 3-year simple interest loan - interest paid at the end of each 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.

SHOW YOUR WORK:

A) What should Ladybug Inc. do? borrow to buy or lease?

B) The lessor, Caterpillar Inc. has a tax rate of 50%, and pre-tax rate of return is 8%.

At an annual receipt of $2.3 million, is Caterpillar Inc. willing to invest and lease the equipment to Ladybug INC?

What would the minimum annual lease payment/receipt on a pre-tax basis be to make Caterpillar willing to invest and lease?

At this level of annual lease payment, is Ladybug willing to lease from Caterpillar?

C) Explain how both a lessee and a lessor may benefit from a lease transaction financially (be sure to discuss the financial benefits specific to a lessee and a lessor). Who may be the losing third party in a lease transaction?