QUESTION 3: Airsonics Limited has been asked by Sunny Exploration Limited to provide an air shuttle service to their oil exploration site. Airsonics will have a two year contract with Sunny with the possibility of renewal for another 4 years. Airsonics has the following choices: Buy the helicopter for $2,000,000, or Arrange a 6 year non cancellable lease, for $400,000 per year, paid at the beginning of each year. Assume that the CCA rate for the helicopter is 30%, and CCA will be claimed at the end of each year. The corporate tax rate is 40%. The weighted average cost of capital is 12% and Airsonics can borrow at 8%. If Airsonics purchases the helicopter, before tax operating cost will be $200,000 per year, payable at the beginning of each year. After 6 years helicopter will be worth either $400,000 or $600,000. Probability that it will worth $600,000 is 3 times as much as that it will worth $400,000. There is 30% chance that after two years contract will not be renewed. In that case helicopter will be sold at a short notice for $1,000,000. Assume asset pool will remain open. If Airsonics leases the helicopter, and contract is not renewed after two years, then Airsonics has to pay a penalty of $300,000 to break the lease. Before tax operating cost will be $150,000 per year, payable at the beginning of the year. Should Airsonics lease or purchase the helicopter?
QUESTION 3: Airsonics Limited has been asked by Sunny Exploration Limited to provide an air shuttle service to their oil exploration site. Airsonics will have a two year contract with Sunny with the possibility of renewal for another 4 years. Airsonics has the following choices: Buy the helicopter for $2,000,000, or Arrange a 6 year non cancellable lease, for $400,000 per year, paid at the beginning of each year. Assume that the CCA rate for the helicopter is 30%, and CCA will be claimed at the end of each year. The corporate tax rate is 40%. The weighted average cost of capital is 12% and Airsonics can borrow at 8%. If Airsonics purchases the helicopter, before tax operating cost will be $200,000 per year, payable at the beginning of each year. After 6 years helicopter will be worth either $400,000 or $600,000. Probability that it will worth $600,000 is 3 times as much as that it will worth $400,000. There is 30% chance that after two years contract will not be renewed. In that case helicopter will be sold at a short notice for $1,000,000. Assume asset pool will remain open. If Airsonics leases the helicopter, and contract is not renewed after two years, then Airsonics has to pay a penalty of $300,000 to break the lease. Before tax operating cost will be $150,000 per year, payable at the beginning of the year. Should Airsonics lease or purchase the helicopter?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:QUESTION 3:
Airsonics Limited has been asked by Sunny Exploration Limited to provide an air shuttle service
to their oil exploration site. Airsonics will have a two year contract with Sunny with the
possibility of renewal for another 4 years.
Airsonics has the following choices:
Buy the helicopter for $2,000,000, or
Arrange a 6 year non cancellable lease, for $400,000 per year, paid at the beginning of each year.
Assume that the CCA rate for the helicopter is 30%, and CCA will be claimed at the end of each
year. The corporate tax rate is 40%. The weighted average cost of capital is 12% and Airsonics
can borrow at 8%.
If Airsonics purchases the helicopter, before tax operating cost will be $200,000 per year,
payable at the beginning of each year. After 6 years helicopter will be worth either $400,000 or
$600,000. Probability that it will worth $600,000 is 3 times as much as that it will worth
$400,000. There is 30% chance that after two years contract will not be renewed. In that case
helicopter will be sold at a short notice for $1,000,000. Assume asset pool will remain open.
If Airsonics leases the helicopter, and contract is not renewed after two years, then Airsonics has
to pay a penalty of $300,000 to break the lease. Before tax operating cost will be $150,000 per
year, payable at the beginning of the year.
Should Airsonics lease or purchase the helicopter?
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