Professional Documents
Culture Documents
Illustration 1 :
The following details relate to an investment proposal of XYZ Ltd.
Investment outlay Rs. 100 lakhs
Lease Rentals are payable at Rs. 180 per Rs.1000
Term of lease 8 years
Cost of capital for the firm is 12%
Find the Present Value of Lease Rentals if
a. Lease Rentals are payable at the end of the year
b. Lease Rentals are payable at the beginning of the year
Solution:
Lease Rentals paid per annum = Rs. 180 10000 = Rs. 18 lakhs
a. If Lease Rentals are payable at the year end:
Present Value of Lease Rentals = Rs. 18 lakhs PV factors for years [ 1-8 ]
= Rs. 18 lakhs PVIFA (12%, 8th year)
= Rs. 18 lakhs 4.9676
= Rs. 89,41,680
b. If Lease Rentals are payable at the begining :
Present Value of Lease Rentals = Rs. 18 lakhs PV factors for years [0-7]
= Rs. 18 lakhs [1 +PVIFA (12%, 7th Year) ]
= Rs. 18 lakhs [1 +4.5638]
= Rs. 100, 14,840
Krishna Joshi
Page 1
7.50 Lakhs
6.00 Lakhs
4.50 Lakhs
3.00 Lakhs
1.50 Lakhs
TOTAL
22.50 Lakhs
50 Lakhs
Interest
40 Lakhs
30 Lakhs
20Lakhs
10Lakhs
Nil
Total Payable : Rs. 50 lakhs + Rs. 22.50 Lakhs = Rs. 72.50 Lakhs
b. If loan is payable in equal installments:
Each installment = Rs.50 Lakhs/PVIFA (15%, 5) = Rs.50 Lakhs/3.3522 = Rs.1491558
Opening
Balance
5000000
4258442
3405650
2424940
1297123
Payment
Installment
(Paid every year)
1491558
750000
1491558
638766
1491558
510848
1491558
363741
1491558
194568
Interest
TOTAL
7457790
2457923
PrincipleBalance
(Opening BalanceInterest rate)
741558
852792
980710
1127817
1297123
4258442
3405650
2424940
1297123
Nil
5000000
Page 2
Illustration 3 :
The following details relate to an investment proposals of HI Ltd.
- Investment outlay Rs.180 lakhs
- Net salvage value after 3 years, Rs. 18 lakhs
- Annual rate of Depreciation 40%
HI Ltd. has two alternatives.
Option I: Borrow and buy the equipment @ 17% p.a, Marginal rate of Tax 35%;
Cost of capital of HI Ltd. 12%
Option II: Lease on 3 years full payout basis@ Rs. 444/Rs.1000 payable annually
in arrear.
Which option HI Ltd. should choose any and why?
Solution:
Working Notes:
Decision Analysis:
1. lease rentals
= Rs. 180 lakhs 444/1000
= Rs. 79.92 *3
=239.76
2. Tax on lease rentals
= Rs. 180 lakhs444/1000 0.35
= Rs. 27.972 lakhs
3. Calculation of Depreciation :
Year 1
180
40%
Year 2
108 (180 - 72)
40%
Year 3
64.8 (108-43.2) 40%
= 72
= 43.2
= 25.92
141.12
Page 3
COST OF LEASING
1. Investment Outlay:
2. Add : Tax Lease Rentals(Working Note 2)
3. Less : Lease rentals (Working Note 1)
4. Less : tax on Depreciation (Working Note 3)
5. Less : PV of Salvage value (Working Note 5)
(Cash Inflow)
(Cash outflow)
180.00
67.19
239.76
41.01
18.0
__________________
298.77
247.19
Krishna Joshi
Page 4
Illustration 6 :
The following are the details regrading the machine to be given on lease by X Ltd.
i.
Cost of machine to the lessor is Rs. 1,00,000 financed 80% through debt
and balance through equity. Cost of debt before tax amount to 20% and
equity 16%.
ii.
The lessor is in 35% tax bracket. The rate of depreciation of machinery is
20% according to diminishing balance method.
iii.
The scrap value of machines is Rs. 10,000 at the end of 5th year.
iv.
Estimated cost for maintenance and general administration in respect of
machine is Rs.1,000 per annum.
v.
The lessee agrees to pay the following:
(a) Annual rent Rs. 36,000 for 5 years. The payment is to be made at
the end of each year.
(b) The security deposit of Rs. 3,000 which is refundable at the end of
lease period without interest.
(c) Management fees (non-refundable) payable at the inception of
lease period is Rs. 2,500.
You are required to decide whether the lessor should lease the machine using
internal rate of return method.
Solution :
Cost of Capital for Lessor
Source
Amount (Rs.)
Equity
20000
Debt
80000
100000
after tax
16%
13%
Krishna Joshi
Page 5
15,000
5,250
9,750
36,000
1,000
16,000
19,000
6,650
12,350
36,000
1,000
12,800
22,200
7,770
14,430
3 6,000
1,000
10,240
24,760
8,666
16,094
36,000
1,000
8,192
26,808
9,383
17,425
Lease revenue
36,000
Add : Sale of machinery (Scrap)
Less : Administration cost
1,000
Less : Refund of deposit - - - Less : Tax liability
5,250
36,000
36,000
36,000
1,000
1,000
1,000
6,650
7,770
8,666
36,000
10,000
1,000
3,000
9,383
29,750
28,350
27,230
26,334
32,617
1,00,000
5,500
94,500
Computation of Internal Rate of Return
Year Cash
outflow
Rs.
0 94,500
N.P.V
Krishna Joshi
Cash
Inflow
Rs
Discount
factor
@ 14%
Present
value
Rs.
Discount
factor
@ 18%
Present
value
Rs.
1 29,750
2 28,350
3 27,230
4 26,334
5 32,617
0.877
0.769
0.675
0.592
0.519
4,290
26,091
21,801
18,380
15,590
16,928
98,790
0.847
0.718
0.609
0.516
0.437
-4,522
25,198
20,355
16,583
13,588
14,254
89,978
Page 6
Krishna Joshi
Page 7
Page 8
Illustration 8 :
Evergreen Ltd. typically writes 5 year leases with rentals payable annually in
arrears. The following information is available about a lease under review.
Equipment cost : Rs. 47 lakh (inclusive of CST @ 10%)
Salvage value : 5% of original cost
After 5 years
Initial Direct cost : Rs. 0.50 lakh (front ended)
Management Fee : Rs 0.75 Lakh (front ended)
The marginal cost of capital to Evergreen Ltd. is 16% and the marginal rate of tax
is 46%.
Krishna Joshi
Page 9
Page 10
Illustration 9 :
A company wishes to acquire an asset costing Rs. 1,00,000. The company has an
offer from
a bank to lend @ 18% repayable in 5 years and installments. A leasing company
has also
submitted a proposal to the Company to acquire the asset on lease at a yearly
rentals of Rs.
280 per Rs. 1000 of the assets value for 5 years payable at year end. The rate of
depreciation
of the asset allowable for tax purposes is 20% on W.D.V with no extra shift
allowance. The
salvage value of the asset at the end of 5 years period is estimated to be Rs. 1000.
Whether the
company should accept the proposal of Bank or leasing company, if the effective
tax rate of
the company is 50%.
Solution :
Borrowing Option
12345678
Tax Net Discount
Year Principle Interest Depre- Shield Cash factor = Discounted
Krishna Joshi
Page 11
Page 12
Page 13
Illustration 11 :
Alfa Ltd. is thinking of installing acomputer. Decide whether the computer is to be
purchased
outright (through 15% borrowing) or to be acquired on lease rental basis. The rate
incometax
may be taken at 40%. The other data available are as under :
Purchase of computer :
Purchase price Rs. 20 lakh
Annual maintenance (to be paid in advance) Rs. 50000 p.a
Expected economic useful life 6 years
Depreciation (for tax purposes) SLM
Salvage value Rs.2 lakhs
Leasing of computer :
Lease charges to be paid in advance Rs. 4.50 lakhs
Maintenance expenses to be borne by lessor. Payment of loan is made in 6 yearend
installments of Rs. 5,28,474 each.
Solution :
Lease Option :
PV of Cash Outflows under Leasing Alternatives [Mmt. in Rs.]
Year end Lease Tax Shield Cash Pvf (9%,n) Total PV
Krishna Joshi
Page 14
Illustration 12 :
Welsh Ltd. is faced with a decision to purchase or acquire on lease a mini car. The
cost of the
Krishna Joshi
Page 15
Page 16
Illustration 13 :
A company is thinking of installing a machine. It is to decide whether the machine
is to be
purchased outright (through 14% borrowings) or to be acquired on lease rent basis.
The firm
is in the 50% tax bracket. The other data available are:
Buying:
Purchase price Rs. 20 lakhs
Expected economic useful life 6 years
Depreciation Straight-line method
Salvage Value Rs. 2 lakhs
Lease Option:
Lease charges (to be paid in adv.) Rs. 4 lakhs
Maintenance Expenses To be borne by the lessor
Payment of Loan 6 year and equal installments of Rs. 5,14,271
Should the company buy or lease ?
Solution :
Buying Option:
Krishna Joshi
Page 17
Krishna Joshi
Page 18