Your ﬁrm needs to either buy or lease $230,000 worth of vehicles. These vehicles have a life of 4 years after which time they are worthless. The vehicles belong in CCA class 10 (a 30% class) and
Can be leased at a cost of $68,000 a year for the 4 years. The corporate tax rate is 34% and the
Cost of debt is 10%.
The lessor in this case has a tax rate of 35%. What is the net advantage of leasing to the lessor?

Question

Quizplus · Accepted Answer

To compare buying vs. leasing, we need to find the after-tax cost of each option.

1) Buying:
The cost of buying the vehicles is $230,000. Since they belong in CCA class 10, we can claim a CCA rate of 30%. This means we can claim $69,000 in CCA each year for the next 4 years. This reduces our taxable income, resulting in a tax savings of:

$69,000 x 34% = $23,460 (tax savings per year)

The cost of debt is 10%, so the after-tax cost of borrowing is:

10% x (1 - 34%) = 6.6%

We can use this rate to calculate the annual after-tax cost of buying:

Year 0: -$230,000 (cost)
Year 1: -$183,460 (cost + tax savings + interest)
Year 2: -$140,223 (cost + tax savings + interest)
Year 3: -$100,846 (cost + tax savings + interest)
Year 4: -$64,839 (cost + tax savings + interest)

Total after-tax cost of buying: -$719,808

2) Leasing:
The cost of leasing is $68,000 per year for 4 years. Since the lessor has a tax rate of 35%, they get a tax deduction for the lease payments. We can calculate the after-tax cost of leasing as follows:

$68,000 x (1 - 35%) = $44,200 (after-tax cost per year)

Total after-tax cost of leasing: -$176,800

The net advantage of leasing is the difference between the after-tax cost of buying and the after-tax cost of leasing:

Net advantage of leasing = -$719,808 - (-$176,800) = -$543,008

Since the net advantage of leasing is negative, it is better to buy the vehicles. Therefore, the best choice is to BUY.

Your ﬁRm Needs to Either Buy or Lease $230,000 Worth