Sterling Manufacturing is pursuing a bold plan to enhance growth of its watch manufacturing business. Management has a couple of financing issues that they need your help in assessing. Sterling's average tax rate is expected to be 20%. 1. It needs a new machine that can help it manufacture innovate new watch models. The fair market value of the new machine is $22,000,000. It has a useful life of 12 years and a salvage value of $500,000 at the end of its life. The applicable CCA rate is 20% and it qualifies for the Accelerated Investment Incentive. Instead of purchasing it, it can lease it for $208,333 per month for a lease term of 12 years. Payments are due at the beginning of the month. Management has asked you to recommend whether to lease or buy the machine. 2. Sterling currently has long term debt of $50,000,000 that has a pre-tax cost of 7.5% and 25 million of shares outstanding. It is considering a proposal from a wealth investor to provide $100 million as a convertible note payable. The term would be 5 years with no annual repayments and principal due in full upon maturity. The interest rate is 4.5% to be paid annually. Each dollar of face value can be converted to 0.15 common shares of the company, at the holder's option. Sterling needs this $100 million in order to finance other work related to its growth strategy. Since the growth strategy is expected to start paying off materially after 6 years, it is excited about this proposal. Management is seeking your advice about whether there are any key risks with pursuing the convertible note payable and whether there are any other financing options it should investigate. Present value of annuity due: P+P o [1-(1+r)-(-1)- P Periodic Payment r = rate per period n = number of periods PV of the tax shield on CCA If subject to the half-year rule: Investment x CCA rate x Corporate tax rate 1+0.5 x Discount rate CCA rate + Discount rate If eligible for the Accelerated Investment Incentive: 1+ Discount rate Investment x CCA rate x Corporate tax rate 1+1.5 x Discount rate CCA rate + Discount rate If eligible for 100% writeof in the first year: Investment x Corporate tax rate 1+ Discount rate x 1 + Discount rate PV of the lost tax shield on CCA on salvage at time of salvage Salvage proceeds x CCA rate x Corporate tax rate CCA rate + Discount rate =