Airsonics Limited has been asked by Sunny Exploration Limited to provide an air shuttle service to their oil exploration site. Airsonics will have a two-year contract with Sunny with the possibility of renewal for another 4 years. Airsonics has the following choices: Buy the helicopter for $2,000,000 or arrange a 6-year non-cancellable lease, for $400,000 per year, paid at the beginning of each year.
Assume that the CCA rate for the helicopter is 30%, and CCA will be claimed at the end of each year. The corporate tax rate is 40%. The weighted average cost of capital is 12% and Airsonics can borrow at 8%.
If Airsonics purchases the helicopter, before-tax operating cost will be $200,000 per year, payable at the beginning of each year. After 6 years, the helicopter will be worth either $400,000 or $600,000. The probability that it will be worth $600,000 is 3 times as much as that it will be worth $400,000. There is a 30% chance that after two years, the contract will not be renewed. In that case, the helicopter will be sold at a short notice for $1,000,000. Assume asset pool will remain open. If Airsonics leases the helicopter and the contract is not renewed after two years, then Airsonics has to pay a penalty of $300,000 to break the lease. Before-tax operating cost will be $150,000 per year, payable at the beginning of the year.
Should Airsonics lease or purchase the helicopter?