Question 4 (28 marks)

CX Airline is considering whether to lease or buy a private jet that costs $5.2 million and will be depreciated straight-line to zero over four years. The private jet can also be leased for $1.51 million annually payable at the end of each year for 4 years. Assume the tax rate is 21% for both CX Airline and the lessor and the before-tax cost of debt for both firms is 8%.

(a) Should CX Airline lease or buy? (11 marks)

(b) Do you think the lessor is willing to offer the lease to CX Airline? Explain. (4 marks)

(c) What is the lease payment for both the lessor and the lessee to be indifferent about the lease? (7 marks)

(d) Suppose now CX Airline pays no taxes for the next four years because of the government policy to support the development of the industry and the tax rate that applies to the lessor is still 21%. Calculate the range of lease payments such that the lease will be profitable for both lessor and lessee. (6 marks)