Practical Problems on LEASING (arranged in CLASS Order)

Lessees Point of view (Problem Nos. 1 to 6)

PROBLEM No.1 (Payments at the end of the year/in arrears)

XYZ Ltd. is the business of manufacturing steel utensils. The firm is planning to diversify and
add a new line of products. The firm either can buy the required machinery or get it on lease. The
machine can be purchased for Rs 1500000/-. It is expected to have a useful life of 5 years with
salvage value of Rs 1, 00,000/- after the expiry of 5 years. The purchase can be financed by 20
percent loan repayable in 5 equal annual installments (inclusive of interest) becoming due at the
end of each year. Alternatively, the machine can be taken on year end lease rentals of Rs. 4,
50,000/- for 5 years. Advise the company, which option should be chosen.

For your exercise, you may assume the following:

The machine will constitute a separate block for depreciation purpose. The company
follows WDV method of depreciation, the rate of depreciation being 25 percent.
Tax rate is 35% and cost of capital is 18%.
Lease rents are to be paid at the end of the year.
Maintenance expenses estimated at Rs 30000/- per year are to be borne by the lessee.
(QP Dec 2014/ Jan 2015); ( QP June/ July 2013) (Illustration 4.1 pg 4.3 from Text
book M.Y Khan), (QP Dec 2009/ Jan 2010), (QP Dec 2013/ Jan 2014).
PROBLEM No.2 (Payments at the beginning of the year/in advance) 4.21

XYZ builders Ltd need to acquire the use of a crane for the construction business and are
considering buying or leasing a crane. The crane costs Rs.10,00,000 and is subject to the straight
line method of depreciation to a zero salvage value at the end of 5 years. In contrast, the lease
rent is Rs.2, 20,000 per year to be paid in advance each year for 5 years. XYZ builders Ltd can
raise debt at 14% payable in annual instalments, each instalment due at the beginning of the year.
The company is in 50% tax bracket. Should it lease or buy the crane.

PROBLEM No.3 (Direct PV Factor /Discount Factor) QP

A company needs equipment which costs Rs.15 lakhs for production purpose. Due to lack of
funds, the company has to either borrow funds or lease the equipment for 5 years. If it is
borrowed, the interest rate is 15%.It has a salvage value of Rs.150000 at the end of 5 years. In
case the equipment is taken on lease, an annual rent of Rs.495000 is charged at the end of the
year. Depreciation is allowed at 15% on the equipment using WDV method. The company is in
the tax bracket of 50%.Applying the discount rate of 14%, evaluate both the options and offer
your comments.
PROBLEM No.4 (Maintenance expense/cost borne by lessor) 4.24

Alfa Ltd. is thinking of installing a computer. Decide whether the computer is to be purchased
outright (through 14% borrowing) to be acquired on rental basis. The company is in 50% tax bracket
.The other data available are:
Purchase of a computer:
Purchase Price: Rs.20, 00,000
Annual Maintenance (to be paid in advance) Rs.50, 000 per year
Expected Economic useful life 6 years
Depreciation (for tax purpose) - Straight line method
Salvage value Rs.200000
Leasing of a computer:
Lease Charges to be paid in advance: Rs.450000
Maintenance expenses to be borne by lessor
Payment of loan: 6 year end equal installments of Rs.514271.
PROBLEM No.5 (Purchase Vs Loan option No borrowings) RKV ltd

XYZ is considering the possibility of purchasing a multipurpose machine for Rs 1000000. The
machine has an expected life of 5 years. The machine generates Rs 6 lakhs per year before
depreciation and tax. The management wishes to dispose the machine at the end of 5 years which
will fetch Rs 100000/-.The depreciation allowable for the machine is 25% on WDV and the
companys tax rate is 50%. The company approaches a NBFC for a 5 year lease for financing the
asset which quoted rate of Rs 28 per thousand per month. Evaluate the purchase option and lease
proposal. Suggest the best option to the company. The cost of Capital of the company is 12% and for
the lease option discount rate is 16%.

PROBLEM No.6 (Lease rentals including portion of revenue of lessee)

Your company is considering acquiring an additional computer to supplement its computer services
to its clients. It has two options:
i. To purchase the computer for Rs.22 lakhs.
ii. To lease the computer for 3 years from a leasing company for Rs.5 lakhs as
annual rent plus 10% of gross revenue. The agreement also requires an additional
payment of Rs.6 lakhs at the end of the third year. Lease rentals are payable at
the year end and the computer reverts to the lessor after the contract period.

The company estimates the computer under review will be Rs.10 lakhs at the end of the third year
.Forecast revenues are:
Year 1 2 3
Amount(Rs.lakhs) 22.5 25 27.5

Annual operating costs excluding depreciation/lease rent of computer are estimated at Rs.9 lakhs
with an additional Rs.1 lakh for startup and training costs at the beginning of first year .These costs
are to be borne by the lessee. Your company will borrow 16% interest to finance the acquisition of
the computer. Repayments are to be made according to the following schedule:
 Year end 1 2 3
Principal(Rs.000) 500 850 850
Interest(Rs.000) 352 272 136
The company uses straight line method to depreciate the assets and pays 50% tax on its income. The
management approaches the company secretary for advice. Which alternative would be
recommended? Why?

LESSORS POINT OF VIEW

PROBLEM No.7 (Lessors view only)

Analyze problem no.1 from lessors point of view assuming cost of capital 14%.Is it financially
profitable for leasing company to lease out the machine?

LESSORS and LESSEES POINT OF VIEW

PROBLEM No.8 (Lessors And Lessees view points)

The controller of General Electronics Corporation of India Ltd has been analyzing the firms
policy regarding computers which are now being leased on a yearly basis on rental amounting to
Rs 100000/- per year. The computers can be bought for Rs 500000/-. The purchase would be
financed by 16 percent loan repayable in 4 equal annual installments ( to be paid at the end of the
year)
On account of rapid technological progress in the computer industry, it is suggested that a 4 year
economic life should be used. It is estimated that the computers would be sold for Rs 200000/-
at the end of 4 years. The company uses the straight line method of depreciation. Corporate tax
rate is 50 %.
1. Comment whether the equipment should be bought or leased?
2. Analyze the financial viability from the point of view of the lessor assuming 14 % cost of
capital.
3. Determine the minimum lease rent at which the lessor would break even (QP May/June
2010)
DISCOUNT YEARS
RATE 1 2 3 4 5
8% 0.9259 0.8573 0.7938 0.7350 0.6806
14% 0.8772 0.7695 0.6750 0.5921 0.5194
16% 0.8621 0.7432 0.6407 0.5523 0.4761
ASSIGNMENT PROBLEMS

PROBLEM No.1 4.45

Agrani Ltd. is in the business of manufacturing bearings .some more product lines are being planned
to be added to the existing system. The machinery required may be brought or may be taken on
lease. The cost of the machine is Rs.40, 00,000 having a useful life of 5 years with the salvage value
of Rs.8, 00,000.The full purchase value of the machine can be financed by 20% loan repayable in
equal instalments falling due at the end of each year. Alternatively, the machine can be procured on
a 5 year lease, yearend lease rentals being Rs.12, 00,000 per annum. The company follows written
down value method of depreciation at the rate of 25%.Its tax rate is 35% and cost of capital is 16%.
I. Advise the company which option it should choose lease or borrow.
II. Assess the proposal from lessors point of view whether leasing is financially viable at 14%
cost of capital.
PROBLEM No.2 4.29

Hypothetical Limited is planning to have an access to a machine for a period of 5 years after
discussions with various financial institutions. The company can have the use of machine for the
stipulated period through leasing arrangement or the requisite amount can be borrowed at 14% to
buy the machine. The firm is in 50% tax bracket. In case of leasing, the firm would be required to
pay an annual year end lease rent of Rs.1200000 for 5 years .All maintenance, insurance and other
costs are to be borne by the lessee. In case of purchase of the machine which costs Rs.343300, the
firm would have 14%, 5-year loan to be paid in 5 equal instalments, each instalment becoming due
at the end of each year .The machine would be depreciated on a straight line basis for tax purpose
with no salvage value.
Advise the company regarding the option it should go for, assuming lease rentals are paid (a) the end
of the year
(b) in Advance
Hire purchase problem liks
http://vle.du.ac.in/mod/book/print.php?id=9925
https://cawinners.files.wordpress.com/2016/04/ipcc-guess-question-papers-group-i.pdf
http://mastermindsindia.com/HIREPURCHASESYSTEM.pdf (answer only)