Question - Bob Co. has decided that it needs ten new modern buses. Buses that are being considered are made by (ABG) and cost $200,000 each for a total of $2 million. To obtain these buses, two alternative financial arrangements are available to Bob Co.
1. It can use the facilities of a Bank for a term loan of five years at the interest rate of 20%. If the company is to take this loan and pay cash to the manufacturer, the list price will be cut by 10%, to $180,000 per bus.
2. The manufacturers can also act as a lessor and offer a five-year lease to Bob Co so that they can obtain uses of Buses without purchasing them. The arrangement calls for Bob Co. to pay $500,000 at the beginning of each year for five years. If the company is to take this option, the Lease Promoting Agency (LPA), a government organization that promotes leasing contracts, will pay the Bob co $160,000 at the end of year 5.
Because of the special circumstances surrounding this case, the investment can be depreciated for tax purposes at a 50% declining rate (that is, exceptionally, the CCA rate is 50% instead of the usual 30% for cars). The capital cost of the buses will be added to the existing CCA pool of BoB co. Because of the heavy usage, the buses will only be good for scrap after five years. The scrap value is estimated to be $12,000 per bus for a total of $120,000. Bob Co will not pay tax for the foreseeable future but the manufacturer's tax rate is 50%..
(a) Should Bob Co buy or lease the buses? Show your work.
(b) What is the NPV lease for the manufacturer?
(c) What is the maximum lease payment that Bob CO is willing to pay?
(d) What is the minimum lease payment that ABG is willing to accept?