Question
The Barrhaven-Bells Corner (BBC) Railway would like to acquire 4 new locomotives to increase its passenger and freight capacity. BBC has two decisions to make:
The Barrhaven-Bells Corner (BBC) Railway would like to acquire 4 new locomotives to increase its passenger and freight capacity. BBC has two decisions to make:
(i) should it undertake this new locomotive purchase project; and
(ii) if the project should be undertaken should BBC lease or buy/borrower.
BBC is considering the following six-year locomotive project:
Purchase the 4 locomotives at a price of $1.5 million each.
Each locomotive will have salvage value of $250,00 after six years
The project will increase BBCs pretax cash flow by $4.0 million a year
Locomotives have a CCA rate of 15 percent.
BBCs WACC is 11% and its tax rate is 35%.
To finance the project BBC is considering the following two options:
Option 1 Issue a six-year bond with a 9% coupon rate
Option 2 Lease the Locomotives The annual lease rate would be $245,000 each year for each of the locomotives), for a six-year contract. These lease payments would be made at the beginning of each year.
1.What would be the Present Value of the Capital Cost Allowance Tax Shield (PVCCATS) due to purchasing the 4 locomotives?
2. Using the NPV capital budgeting technique should BBC undertake this project?
Assume that the Present Value of the Capital Cost Allowance Tax Shield (PVCCATS) for purchasing the 4 locomotives is $1.025 million (Note: this assumption is not necessarily the answer any of the questions above).
3. What are the present value of the lease payments to be used in the Net Advantage to leasing (NAL) analysis?
Assume that the NPV of this locomotive project is positive, and BBC has decided to undertake this project (Note: this assumption is not necessarily the answer any of the questions above).
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