672 Part Seven Debt Financing
bre44380_ch25_652-672.indd 672 10/05/15 12:54 PM
These are net leases; all operating costs are absorbed by Magna Charter.
How would you advise Agnes Magna, the charter company’s CEO? For simplicity assume
five-year, straight-line depreciation for tax purposes. The company’s tax rate is 35%. The
weighted-average cost of capital for the bush-plane business is 14%, but Magna can borrow at
9%. The expected inflation rate is 4%.
Ms. Magna thinks the plane will be worth $300,000 after five years. But if the contract
with the mining company is not renewed (there is a 20% probability of this outcome at year 1),
the plane will have to be sold on short notice for $400,000.
If Magna Charter takes the five-year financial lease and the mining company cancels at
year 1, Magna can sublet the plane, that is, rent it out to another user.
Make additional assumptions as necessary.- Leasing and IRRs Reconstruct Table 25.2 as a leveraged lease, assuming that the les-
sor borrows $80,000, 80% of the cost of the bus, nonrecourse at an interest rate of 11%. All
lease payments are devoted to debt service (interest and principal) until the loan is paid off.
Assume that the bus is worth $10,000 at the end of the lease. Calculate after-tax cash flows on
the lessor’s equity investment of $20,000. What is the IRR of the equity cash flows? Is there
more than one IRR? How would you value the lessor’s equity investment? - Valuing leases Suppose that the Greymare lease gives the company the option to purchase
the bus at the end of the lease period for $1. How would this affect the tax treatment of the
lease? Recalculate its value to Greymare and the manufacturer. Could the lease payments be
adjusted to provide a positive NPV to both parties?