Question

Suppose Bombardier can lease their fleet of planes from Boeing, for $9,000/year per plane for four years under an operating lease. This cost includes maintenance programs, and unlimited mileages. Alternatively, it can purchase each plane for $40,000. Assume Bombardier has a borrowing cost of 4% and a tax rate of 35%, and the plane can be sold for 20% its initial value at the end of six years.

(i) If Bombardier will depreciate for tax purposes the fleet of planes on a 150% declining balance basis over the next six years, and if the operating lease qualifies as a true tax lease, is it better to finance the purchase of the plane or to lease it?

(ii) Suppose that if Bombardier buys the fleet of planes, it will use accelerated depreciation for tax purposes. Specifically, the CCA rate will be 45% and any undepreciated capital cost (UCC) in year 6 will be taken as a terminal loss. Compare leasing with purchase in this case.

(iii) What other factors should Bombardier consider when evaluating leasing vs. buying a fleet of planes?

We're required to use depreciation tax savings formulas and present value of dereciation tax savings and other basic finance formulas such as annuity, perpetuity and others. All the information provided is complete.

Answer 1

(a) It is better to purchase the plane. Total costs associated with Operating Lease $36,000, and with Finance Lease (on purchase of plane is $32,544.69. Following is the detailed calculations. Not to mention when purchased, fleet can be used for six years, but for four years when leased unless it is rolled over.

(b)  It is still better to purchase the plane.Total costs associated with Operating Lease $36,000, and with Finance Lease (on purchase of plane is $27,896.25. Following is the detailed calculations.

(c) In case of purchse, benefits are long-term (short-term costs can be more as evident from the above tables), you may get salvage value even when book value may not be positive, and also, you own the plane. However, operating lease may make sense if you are particularly looking for very short-term, and also if industry is changing dynamically due to technological interventions (your purchased fleet may become obselete).