Question

 

World of Leasing Limited (WLL) is trying to determine the lease payment it should quote for the construction trucks it is considering purchasing for leasing. Assume that each truck costs $200,000, has a 5 year useful life and a CCA rate of 50%. Before tax operating cost of the truck is $50,000 per year paid by the owner (lessor) of the asset. The corporate tax rate is 40%, before tax cost of debt is 8%, and risk free rate is 4%. Cost of capital is 10%. CCA tax shield will be claimed at the end of the year and the lease payment and operating costs will be at the beginning of the year.

a. Determine the annual lease payment if the resale value of the truck is $60,000 after 5 years. Assume asset pool is open.

b. Determine the annual lease payment if the resale value of the truck is $60,000 after 5 years. Assume asset pool is closed.

c. Continuing with b) above, suppose OnlyLease Inc. (OLI) has a corporate tax rate of 0%, cost of debt is 8%, and cost of capital is 12%. What is the maximum lease payment OLI would be willing to make?

d. Within what range of values WLL and OLI can make a deal?

Answer 1

 

To arrive at Annuity, Let us first determine the net cash flows that will happen every year then we will calculate the Present values of these by using below formulae for all the years:

PV = FV / (1+Interest)^time

Once we have the PV of all cash flows we can divide them into equal installments using the below formulae:

Annuity Value = Present Value / Annuity factor

Annuity factor will be calculated as = Summation of (1+Cost of capital)^years.

Detailed Calculations below:

	0	1	2	3	4	5
Innitial Inv	(200,000)
Maintainance	(50,000)	(50,000)	(50,000)	(50,000)	(50,000)
Asset Sold						60,000
Net Cash Flows	(250,000)	(50,000)	(50,000)	(50,000)	(50,000)	60,000
Present value	(250,000)	(45,455)	(41,322)	(37,566)	(34,151)	37,255
Sum of PV	(371,238)
Annuity	97,932