Your company is considering the purchase of a ﬂeet of cars for $195,000. It can borrow at 8.5%. The cars can be leased for $55,000 per year and will be worthless at the end of four years. The
Corporate tax rate is 34% and the cars belong in CCA class 10 (a 30% class). If you do not expect to
Pay taxes for the next four years, what is the net advantage to leasing?

Question

Quizplus · Accepted Answer

First, let's calculate the depreciation allowance for each year. The initial cost of the cars is $195,000, and they belong in CCA class 10, which has a 30% depreciation rate. Therefore, the depreciation allowance per year is:

Year 1: $195,000 x 0.3 = $58,500
Year 2: ($195,000 - $58,500) x 0.3 = $40,950
Year 3: ($195,000 - $58,500 - $40,950) x 0.3 = $28,665
Year 4: ($195,000 - $58,500 - $40,950 - $28,665) x 0.3 = $20,065.50

Next, let's calculate the after-tax cost of leasing for each year:

Year 1: $55,000 - ($58,500 x 0.34) = $19,410
Year 2: $55,000 - ($40,950 x 0.34) = $33,037
Year 3: $55,000 - ($28,665 x 0.34) = $40,190
Year 4: $55,000 - ($20,065.50 x 0.34) = $46,290

The total after-tax cost of leasing over four years is:

$19,410 + $33,037 + $40,190 + $46,290 = $138,927

Now, let's calculate the after-tax cost of borrowing to buy the cars. The interest expense will be:

$195,000 x 0.085 = $16,575 per year

The interest expense is tax-deductible, so the after-tax cost of borrowing for each year is:

Year 1: $16,575 x 0.66 = $10,936.50
Year 2: $16,575 x 0.66 = $10,936.50
Year 3: $16,575 x 0.66 = $10,936.50
Year 4: $16,575 x 0.66 = $10,936.50

The total after-tax cost of borrowing over four years is:

$10,936.50 + $10,936.50 + $10,936.50 + $10,936.50 = $43,746

To calculate the net advantage to leasing, we subtract the after-tax cost of leasing from the after-tax cost of borrowing:

$43,746 - $138,927 = -$95,181

Since the net advantage to leasing is negative, it is not a good choice. Therefore, buying the cars is the best choice.

Your Company Is Considering the Purchase of a ﬂEet of Cars