Reference no: EM132983569

Questions -

Q1. M/s Gama & Co. is planning of installing a power-saving machine and are considering buying or leasing alternative. The machine is subject to the straight-line method of depreciation. Gama & Co. can raise debt at 14% payable in five equal annual installments of Rs 1,78,858 each, at the beginning of the year. In the case of leasing, the company would be required to pay an annual end-of-year rent of 25% of the cost of the machine for years.

The company is in the 40% tax bracket. The salvage value is estimated at Rs 24,998 at the end of 5 years.

Evaluate the two alternatives and advise the company by considering the after-tax cost of debt concept under both alternatives.

PV factors 0.9225, 0.8510, 0.7851, 0.7242, 0.6681 respectively, for 1 to 5 years.

Q2. 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 bought or maybe taken on lease. The cost of the machine is Rs 40,00,000 having a useful life of 5 years with a salvage value of Rs 8,00,000. The full purchase value of the machine can be financed by a 20% loan repayable in five equal installments falling due at the end of each year. Alternatively, the machine can be procured on a 5-year lease, year-end lease rentals being Rs 12,00,000 per annum. The company follows the written down value method of depreciation at the rate of 25%. The company's tax rate is 35 percent and the cost of capital is 16 percent.

(i) Advise the company which option it should choose-lease or borrow.

(ii) Assess the proposal from the lessor's point of view examining whether leasing the machine is financially viable at 14% cost of capital (Detailed working notes should be given. Calculations can be rounded off to Rs lakh).

Q3. Engineers Ltd is in the business of manufacturing nut bolts. Some more product lines are being planned to be added to the existing system. The machinery required may be taken on lease. The cost of the machine is Rs 20,00,000 having a useful life of 5 years with the salvage value of Rs 4,00,000 (consider short-term capital loss/gain for the Income Tax). The full purchase value of the machine can be financed by a bank loan at the rate of 20% interest repayable in five equal installments, falling due at the end of each year. Alternatively, the machine can be procured on a 5 years lease, year-end lease rentals being Rs 12,00,000 per annum. The company follows the written-down value method of depreciation at the rate of 25 percent. The company's tax rate is 35 percent and the cost of capital is 14 percent.

(i) Advise the company which option it should choose-lease or borrow.

(ii) Assess the proposal from the lessor's point of view examining whether leasing the machine is financially viable at 14 percent cost of capital. Detailed working notes should be given.