Comprehensive. Magna Charter has been asked to operate a Beaver bush plane for a mining company…

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Comprehensive. Magna Charter has been asked to operate a Beaver bush plane for a mining company exploring in Yukon. Magna will have a one-year contract with the mining company and expects that the contract will be renewed after one year, for the remaining four years of the exploration program . If the mining company renews after one year, it will commit to use the plane for four more years. Magna Charter has the following choices:
Buy the plane for $500,000.
Arrange a 5-year, non-cancellable, net financial lease at a rate of $75,000 per year, paid in advance.
How would you advise Agnes Magna, the chaner company"s CEO? Assume that the CCA rate is 25 percent and Magna has many other airplanes in its asset pool. The first CCA deduction is made at the end of the first year. The company"s tax rate is 35 percent. The weighted-average cost of capital for the bush plane business is 14 percent, but Magna can borrow at 9 percent. Ms. Magna thinks the plane will be worth $300,000 after 5 years. She also thinks that there is a 20 percent chance that the contract will not be renewed at Year 1. If the contract is not renewed, the plane will have to be sold on short notice for $400,000.
If Magna Charters takes the 5-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.

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