Air Charter Limited has been asked by GoldDiggers Limited to provide an Air Shuttle service to the gold exploration site. AirCharter will have a one year contract with the Gold Diggers with the possibility of renewal for another 4 years.
AirCharter has the following choices:
Buy the helicopter for $500,000, or
Arrange a 5 year non cancellable lease, for $100,000 per year, paid at the beginning of each year.
Assume that the CCA rate for the helicopter is 25%, and CCA will be claimed at the end of each year. The corporate tax rate is 35%. The weighted average cost of capital is 14% and Air Charter can borrow at 9%.
If Air Charter purchases the helicopter, before tax operating cost will be $100,000 per year, payable at the beginning of each year. Helicopter will be worth $300,000 after 5 years. There is 20% chance that after one year contract will not be renewed. In that case helicopter will be sold at a short notice for $400,000. Assume asset pool will remain open.
If AirCharter leases the helicopter, and contract is not renewed after one year, then AirCharter has to pay a penalty of $100,000 to break the lease. Before tax operating cost will be $80,000 per Should AirCharter lease or purchase the helicopter?