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What is the net present value of the net tax shield on CCA

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Reference no: EM133001360

Question - Minute Recreational Airline (MRA) has decided to acquire a 45-seat regional jet from an airplane manufacturer. The jet has an initial purchase price of $15 million. Company management now needs to determine whether it should buy or lease the jet.

If MRA purchases the jet, the Federal government has offered a one-time subsidy of $500,000, to be applied to the purchase price of the jet. The company would finance the purchase with a $15 million bank loan at an interest rate of 12% and 10 years to maturity. MRA would incur costs associated with maintenance and insurance of $300,000 per year.

If MRA acquires the jet by leasing from the airplane manufacturer, it would have to pay lease payments of $2.5 million per year over 10 years, with the lease payments being payable in advance. MRA would receive the tax shield on the lease payment at the end of the year the lease payment is made. For the duration of the jet's lease, the manufacturer would pay the maintenance and insurance costs.

The salvage value of the jet after 10 years is expected to be $1 million. MRA has a corporate tax rate of 35%. The WACC for the airplane purchase is 10%. Assume the CCA rate is 25%.

Note: Don't forget the minus sign for the negative cash flows!

1. What is the PV of the lease payments?

2. What is the NPV of the lease option?

3. What is the PV of after-tax operating costs?

4. What is the present value of the salvage value?

5. What is the net present value of the net tax shield on CCA?

6. What is the NPV of the borrow to purchase option?

Reference no: EM133001360

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