Larine industries wants an airplane available for use by its corporate staff. The airline that the company wishes to acquire, a superjet, can be either purchased or leased from manufacturer.
Larine industries cost of capital is 20% and the tax rate is 30%.
The company has made the following evaluation of the two alternatives:
Purchase alternative
|
Purchase cost price
|
2 550 000
|
|
Annual cost of servicing and licence
|
27 000
|
|
Annual depreciation
|
50000
|
|
Repairs
|
|
|
first year
|
9000
|
|
Second year
|
9000
|
|
Third year
|
9000
|
|
Forth year
|
15000
|
|
Fifth year
|
30000
|
The superject would be solved after five years. Based on current values, the company would be able to sell it for one third of its original cost at the end of the five year period.
Lease alternative
If the superjet is leased, then the company would have to make an immediate deposit of 150 000 to cover any damage during use. The lease would run for five years, at the end of which time the deposit would be refunded.
The lease would require an annual rental payment of R600 000 at the end of each year. As part of the lease cost, the manufacture would provide all servicing and repairs.
At the of the five-year period, the plane would revert to the manufacturer, as owner.
Required:
1. Calculate the total after-tax cost of the present values of the cash flows associated with each alternative.
2. Which financial alternative would you recommend that the company accept? Why?