You run a construction equipment rental company, renting out loaders, generators, lifts and similar equipment on short term rentals. In the past, you have purchased the equipment which you then rent out, but business is expanding quickly, and so you are considering leasing equipment rather than buying it. For your economic analysis, you are considering three options.

1 Option 1:

Buy a new bulldozer

Capital cost: $300,000

Financing:

bank loan for full amount

10% annual interest rate

assume only interest paid during the year; principal paid in full at end of term

Purchase frequency: every three years

Salvage value after 3 years: $180,000

Operating and maintenance costs:

$25,000 for the first year $7500 increase every year

Insurance: $9500 per year

Transportation to and from job sites: 5% of revenue

Revenue $175,000 in the first year of operations

$30,000 increase every year $300,000 maximum annual revenue Option 2: Buy a new bulldozer

Capital cost: $300,000

Financing: bank loan for full amount

10% annual interest rate assume only interest paid during the year; principal paid in full at end of term

Purchase frequency: every six years

Salvage value after 6 years: $135,000

Operating and maintenance costs:

$25,000 for the first year $7500 increase every year

Overhaul every three years $150,000

does not affect operating and maintenance costs

Insurance: $9500 per year

Transportation to and from job sites: 5% of revenue

Revenue $175,000 in the first year of operations

$30,000 increase every year

$300,000 maximum annual revenue 2 Option 3: Lease a bulldozer

Lease cost: $45,000 per year

Lease length: five years, fixed

Operating and maintenance costs:

$25,000 for the first year

$7500 increase every year

Overhaul

every three years

$150,000

does not affect operating and maintenance costs

Insurance: $9500 per year

Transportation to and from job sites: 5% of revenue

Revenue $175,000 in the first year of operations

$30,000 increase every year

$300,000 maximum annual revenue

You will need to compare the three options under three different scenarios and make a recommendation, which option is the best for each of these three scenarios.

(2) a) Describe the approach(es) you used to compare the three Options. Provide some justification.

(6) b) Scenario 1: Basic analysis Perform basic analysis with neither taxes nor inflation. Comment on the construction of the table, such as why certain columns are needed and what might change from row to row.

(6) c) Scenario 2: Effects of taxation Redo your analysis to determine if including taxation affects your recommendation. Assume a Capital Cost Allowance of 20% (for newly acquired assets, half the rate for the first year) and apply depreciation where appropriate. Use an open-book UCC when disposing and acquiring bulldozers. Assume a tax rate of 40%. Comment on the construction of the table, such as why certain columns are needed and what might change from row to row.

(6) d) Scenario 3: Effects of inflation Redo your analysis to determine if including inflation on top of taxation affects your recommendation. Assume an inflation rate of 6%. Assume purchase and salvage values remain fixed and that the maximum revenue will still apply, but will be in real terms. For the remainder of the values, provide justification for why you did or did not included the effects of inflation in the values.

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