Ladybug Inc. is considering a leasing arrangement to finance some construction equipment that it needs for...
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Ladybug Inc. is considering a leasing arrangement to finance some construction equipment that it needs for the next three years. The equipment will be obsolete and worthless after 3 years. The firm will depreciate the cost of the equipment at a CCA rate of 20%. It can borrow $4,800,000 (the purchase price) at 10% per year and buy the equipment, or it can make 3 equal end-of-the-year payments of $2,300,000 each and lease the equipment. The loan obtained from the bank is a 3-year simple interest loan, with interest paid at the end of the year. Ladybug's tax rate is 40%. Annual maintenance and insurance costs associated with ownership are estimated at $240,000, but these costs would be borne by the lessor if Ladybug leases. Required: A) What would you recommend Ladybug to do, borrow to buy or lease? B) The lessor, Caterpillar Inc. has a tax rate of 50% and its pre-tax rate of return is 8%. At an annual receipt of $2,300,000, is Caterpillar Inc. willing to invest and lease the equipment to Ladybug? How much would the minimum annual lease payment/receipt on a pre-tax basis be so that Caterpillar is willing to invest and lease? At this level of annual lease payment, is Ladybug willing to lease from Caterpillar? C) Briefly explain how come both a lessee and a lessor may benefit from a lease transaction financially (be sure to discuss what the financial benefits are specific to a lessee and a lessor). Who may be the losing third party in a lease transaction? Ladybug Inc. is considering a leasing arrangement to finance some construction equipment that it needs for the next three years. The equipment will be obsolete and worthless after 3 years. The firm will depreciate the cost of the equipment at a CCA rate of 20%. It can borrow $4,800,000 (the purchase price) at 10% per year and buy the equipment, or it can make 3 equal end-of-the-year payments of $2,300,000 each and lease the equipment. The loan obtained from the bank is a 3-year simple interest loan, with interest paid at the end of the year. Ladybug's tax rate is 40%. Annual maintenance and insurance costs associated with ownership are estimated at $240,000, but these costs would be borne by the lessor if Ladybug leases. Required: A) What would you recommend Ladybug to do, borrow to buy or lease? B) The lessor, Caterpillar Inc. has a tax rate of 50% and its pre-tax rate of return is 8%. At an annual receipt of $2,300,000, is Caterpillar Inc. willing to invest and lease the equipment to Ladybug? How much would the minimum annual lease payment/receipt on a pre-tax basis be so that Caterpillar is willing to invest and lease? At this level of annual lease payment, is Ladybug willing to lease from Caterpillar? C) Briefly explain how come both a lessee and a lessor may benefit from a lease transaction financially (be sure to discuss what the financial benefits are specific to a lessee and a lessor). Who may be the losing third party in a lease transaction?
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A To determine whether Ladybug should borrow to buy or lease the equipment it is necessary to compare the cost of borrowing and ... View the full answer
Related Book For
Foundations of Financial Management
ISBN: 978-1259024979
10th Canadian edition
Authors: Stanley Block, Geoffrey Hirt, Bartley Danielsen, Doug Short, Michael Perretta
Posted Date:
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