The Barrhaven-Bell’s Corner (BBC) Railway would like to acquire 4 new locomotives to increase its passenger and freight capacity. BBC has two decisions to make:
(i) should it undertake this new locomotive purchase project; and
(ii) if the project should be undertaken should BBC lease or buy/borrower.
BBC is considering the following six-year locomotive project:
· Purchase the 4 locomotives at a price of $1.5 million each.
· Each locomotive will have salvage value of $250,00 after six years
· The project will increase BBC’s pretax cash flow by $4.0 million a year
· Locomotives have a CCA rate of 15 percent.
· BBC’s WACC is 11% and its tax rate is 35%.
To finance the project BBC is considering the following two options:
Option 1 – Issue a six-year bond with a 9% coupon rate
Option 2 – Lease the Locomotives – The annual lease rate would be $245,000 each year for each of the locomotives), for a six-year contract. These lease payments would be made at the end of each year.
What would be the Present Value of the Capital Cost Allowance Tax Shield (PVCCATS) due to purchasing the 4 locomotives?
Question 13 options:
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$1.044 million |
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$1.052 million |
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$1.135 million |
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None of the above |
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$0.923 million |
