July 16, 2003

218 Overcast Avenue, Suite 2000
Toronto
Ontario, M2K 2W2

Attention: Jack Rambrandt

Dear Mr. Rambrandt

You have asked us to report to you on the following alternatives of acquiring a passenger vehicle:

• Lease the car
• Purchase the car and finance it
• Purchase the car and pay cash

In our calculations, we have noted that the car will be purchased or leased by a GST registered business. We have also determined that the proprietor of the business will use the car.

The relevant information for making the comparison appears on the attached “Schedule A” and the result of the comparison appears on  “Schedule B”. As you can see, the best alternative is to lease the car, which is the lowest amount displayed at the bottom of the three columns.

You may ask, what methodology did we use in making this comparison. One way to make this comparison is simply to add up all the costs and subtract all the tax savings and come up with a number. However, this answer will not be accurate because it ignores the time value of money. A dollar you pay now is worth more than a dollar you pay in the future. So, we have discounted all future costs and tax savings to its present values. We have used the market interest rate – assumed to be the interest rate offered on your best financing deal – to discount all costs and tax savings.

To make a meaningful comparison between a car lease and a car purchase, we have assumed that at the end of the lease, in all scenarios you will neither own the car nor have any debts on account of the car.  Therefore the following assumption would have to be made.

1. Term of the lease and the term of the loan are the same.
2. The leased car is returned at the end of the term of the lease and the purchased car is sold after the expiry of the same time period as the term of the lease.
3. At the end of term, the loan is repaid from the proceeds of the sale of the car at its residual value.
4. The residual value (plus sales taxes) of the leased car and the balance of loan are equal.

The following is a list of factors used to make the comparison. Negative numbers denote benefits, while positive numbers represent costs:

A detailed explanation of the above factors, should you wish to acquaint yourself more with the methodology, appears on “Schedule C”.

Should you have anymore questions please call the undersigned.

Yours truly,

Joseph Tavana

1.      Present Value of Cash Outflow.

The cash outflow when buying the car in cash equals the total payment to the dealer (including sales taxes) less the cash received (excluding sales tax) when the car is sold; when leasing a car the cash outflow is total down payment and lease payments. In the case of financing the car, payments are made to the lender over a period of time including the repayment of loan balance when the car is sold.  To properly compare the cost of the three methods one has to calculate the present value of the future stream of payments. In order to make this calculation an appropriate rate of interest should be used.  If the appropriate rate of interest is 10% then a payment of $110 one year from now equals a payment of $100 today.  In our calculation we have assumed that the most appropriate interest rate for calculating the present value is the market rate of interest.  We have further assumed the market interest rate to be the best interest rate available to the purchaser of the car.

One point to note is that interest rates are calculated as if interest was paid semi-annually.  It is natural that 12% per annum interest paid once at the end of the year is of a lower value than 12 payments of 1% per month.

2.  Present Value of Benefit or Cost of Utilizing Your Own Cash.

When paying cash for a car or making a down-payment one should consider the earning power of the cash that is to be used to make these payments. The cost of the loss of this earning should be compared to the savings in loan interest expense.  One should also take into account the tax on the interest income, unless the car is used in business and the interest paid is deductible. Therefore, the after tax comparison is relevant.  Once the income level and province of residence of the owner is entered the program displays the relevant marginal tax rate.  This marginal tax rate is used to calculate the net after tax interest earned on the cash.  If the comparison shows that your net after tax interest income is less than the interest rate you have to pay on your car loan, then there is a benefit in paying as much down-payment, as you can or buying the car outright.  This calculation is added to the cost or subtracted from it depending on whether it is a cost or benefit.  As this cost or the benefit accrues over the term of the loan, in order to do an accurate comparison, the program calculates the present value of the net cost or benefit. To calculate the present value we have assumed that the costs or benefits are realized at the end of the borrower or lessee’s fiscal years.

3. Present Value of Cash Inflow (From income tax savings)

If the car is used in business, the expenses, with certain limitations, can be deducted from business income.   This deduction will result in a tax saving; subject to the business being profitable. The deductions (except for operating expenses that would be the same under all scenarios) for each fiscal year are calculated using the rules of the Income Tax Act.  The tax savings accruing to the owner of the car or the holder of the lease is the amount of the deduction multiplied by his marginal tax rate.  The program calculates the marginal tax rate after you have input the province of your residence and your annual income.

 The tax savings are not immediate and materialize at certain future dates.  To properly evaluate the tax benefits their present value is calculated.  In calculating the present value we used the interest rate payable on the car loan, which, we have assumed to be equal, the market rate of interest.

We have assumed that tax benefits materialize at the end of the fiscal years except for the last fiscal year when the benefit is taken to realize at end of the last month, when the lease ends.  The program, for simplicity, ignores that taxes have to be paid in quarterly or monthly installments or that they are due several months after the fiscal year-ends.

4.  Present Value of Tax or Tax Savings on the disposal of the car.

When the car is sold, assumed to be when the term of the lease ends, there could be a taxable gain (recapture) or a taxable loss (terminal loss). If the cost of the car is less than the maximum allowable for depreciation (Class 10) then the recapture results in additional tax, which increases the cost of ownership, while a terminal loss results in tax savings. When the cost of the car exceeds the maximum allowable for depreciation (Class 10.1) neither a recapture is assessed, nor is a terminal loss allowed.

5. Present Value of GST input-credit.          

If a business is registered for Goods & Services Tax, the GST paid on the purchase of a car or on the lease of one is recovered subject to limitation and percentage use of the car for business. See details in “Schedule D”.

GST input credit is received or is deducted from GST payable at a future date.  To have a meaningful comparison the present value of the input credits enjoyed in the future is calculated and used in our computations.  We have assumed that the future dates when the credit is enjoyed are at the end of the fiscal years; except, in the last year of lease or ownership when the credit is enjoyed at the end of the month in which the lease ends. We have ignored that often GST is remitted on a quarterly basis and that the effect of the GST input credit does not materialize until one month after the end of the GST quarter. Although, this assumption may not be accurate in all cases it is accurate enough for the purpose of computing the present value of the GST benefits realized in the future.