Question: A business friend has offered to sell you her truck for $ 1 0,000; she will then lease the truck back from you. The lease calls for annual lease payments over 4 years, payable at the beginning of each year, with tax savings available at year-end. It is expected that the truck will have no residual value at the end of the 4 years, and capital cost allowances can be claimed at a rate of 25 percent on a declining balance. Assume that you have other assets in the class. Your tax rate is 30 percent, and you want to achieve an effective after-tax return on your capital of 12 percent per year.
(a) How high would the lease payments have to be?
(b) Assume that you would finance $7,500 of the acquisition price of the truck by borrowing from the bank at an interest rate of 15 percent. Given the lease payments calculated under (a), what return would you then achieve on your remaining equity investment of $2,500?
(c) How would your answer under (a) change if the lease payments were monthly, payable at the beginning of each month, with tax shields still available at year-end?