Reference no: EM132930774

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.

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

Problem (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.