Lalithchandra.B.N.
LEASING PROBLEMS
Problem No:-1
XYZ Ltd. is in the business of manufacturing of steel utensils. The firm is planning to diversify and
add a new product line. The firm either can buy the required machinery or get it on lease.
The machine can be purchased for Rs. 15, 00,000. It is expected to have a useful life of 5 years
with a salvage value of Rs. 1, 00,000 after the expiry of 5 years. The purchase can be financed by
20 per cent 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. Advice the company on the option it should choose. For your exercise, you may assume
the following:
1) The Machine will constitute a separate block for depreciation purposes. The company follows
written down value method of depreciation, the rate of depreciation being 25%.
2) Tax rate is 35 per cent and cost of capital is 18 per cent.
3) Lease rentals are to be paid at the end of the year.
4) Maintenance expenses estimated at Rs. 30,000 per year are to be borne by the lessee.
5) The lessor’s WACC is 14%. Is it financially profitable for leasing company to lease out the
machine?
PROBLEM NO:-2
ABC Ltd. Sell computer services to its client. The company has recently completed a feasibility
study and decided to acquire an additional computer, the details of which are as follows:
1) The purchase price of the computer is Rs 2, 30,000; Maintenance, property taxes and insurance
will be Rs 20,000 per year. The additional expenses to operate the computer are estimated at
Rs. 80,000. If the computer is rented from the owner, the annual rent will be Rs.85, 000, plus
5% of annual billings. The rent is due on last day of each year.
2) Due to competitive conditions, the company feels that it will be necessary to replace the
computer at the end of three years with a more advanced model. Its resale value is estimated
at Rs. 1, 10,000
3) The corporate income tax rate is 50% and the straight line method of depreciation is followed.
4) The estimated annual billing for the services of the new computer will be 2, 20,000 during the
first year, and ` 2, 60,000 during the subsequent two years.
5) If the computer is purchased, the company will borrow to finance the purchase from a bank
with interest at 16% per annum. The interest will be paid regularly, and the principal will be
returned in one lump sum at the end of the year 3.
Should the company purchase the computer or lease it? Assume (i) straight line method of
depreciation, (ii) salvage value of ` 1, 10,000 and evaluate the proposal from the point of view of
lessor if its cost of capital is also 12%.
PROBLEM NO:-3
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 may be taken on
lease. The cost of 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 machine can be financed by 20% loan 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
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written down value method of depreciation at the rate of 25%. Company’s tax rate is 35 per cent
and cost of capital is 16 per cent:
1) Advise the company which option it should choose – lease or borrow.
2) 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. lakhs).
PROBLEM NO:-4
ABC Company has decided to acquire a Rs. 5, 00,000 pulp control device that has a useful life of ten
years. A subsidy of 50,000 is available at the time the device is acquired and placed into service.
The device would be depreciated on straight-line basis and no salvage value is expected. The
company is in the 50% tax bracket. If the acquisition is financed with a lease, lease payments of
Rs.55, 000 would be required at the beginning of each year. The company can also borrow at 10%
repayable in equal installments. Debt payments would be due at the beginning of each year:
(i) What is the present value of cash outflow for each of these financing alternatives, using the
after-tax cost of debt?
(ii) Which of the two alternatives is preferable?
PROBLEM NO:-5
M/s Gama & Co. is planning of installing a power saving machine and are considering buying or leasing
alternative. The machine is subject to 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 case of leasing, the company would be required to pay an annual end of year rent of 25% of
the cost of machine for 5 years.
The Company is in 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 after tax cost of debt concept
under both alternatives.
P.V. factors 0.9225, 0.8510, 0.7851, 0.7242, and 0.6681 respectively for 1 to 5 years.
PROBLEM NO:-6
The following data are furnished by the Hypothetical Leasing Ltd.
Investment Cost
Primary Lease term
Estimated Residual Value after the Primary period
Pre-tax required rate of Return
(HLL).
Rs 500 lakhs
5 Years
Nil
24%
The HLL seeks your help in determining the annual lease rentals under the following rental
structures.
A) Equated, B) Stepped Up (an annual increase of 15%), C) Ballooned (Annual rental of Rs 80 Lakh
for years1-4) and D) Year’s deferment period).
You are required to compute the relevant annual rentals.
PROBLEM NO:-7
Fair finance, a leasing company, has been approached by a prospective customer intending to acquire
a machine whose Cash Down price is 3 crores. The customer, in order to leverage his tax position,
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has requested a quote for a three year lease with rentals payable at the end of each year but in a
diminishing manner such that they are in the ratio of 3: 2: 1. Depreciation can be assumed to be on
straight line basis and Fair Finance’s marginal tax rate is 35%. The target rate of return for Fair
Finance on the transaction is 10%.
Required:
Calculate the lease rents to be quoted for the lease for three years
PROBLEM NO:-8
OYO Finance is a hire purchase and leasing company who have been approached by a local small scale
business interested in acquisition of a machine through leasing
The price quoted by the manufacturer of the machine is 3, 00,000 10% tax is extra. The proposed
lessee desires to have a primary lease period of 5 years.
OYO Finance target rate of return on the transaction is 8% post-tax on the outlay. They
wish to fix annual lease rents which are to be payable in arrears at the end of each year. The
effective Income tax rate is 50%. The income tax rate of depreciation on the machine is 25%.
Calculate the annual lease rent to be charged by OYO Finance Ltd.
PROBLEM NO:-9
UBER leasing Ltd. is in the process of making out a proposal to lease certain equipment to a usermanufacturer. The cost of the equipment to be Rs 10 lakhs and the primary period of lease to be
lease to be 10 years. UBER leasing is able to give you the following additional information:
1) The machine can be depreciated fully over the 10 years on Straight Line basis (assume this
to be acceptable for IT purposes).
2) The current effective tax rate for UBER leasing is 40% and they expect to go down to 30%
from the beginning of the 6th year of the lease.
3) It is the normal objective of UBER to make a 10% post-tax return in its lease pricing.
4) Lease management fee of 1% of the value of the asset is usually collected from the lessees
from
5) The lessess upon signing of the contract of lease, to cover the overhead costs related to
processing of the proposal.
6) Annual lease rents are collected at the beginning of every year.
You are require to determine the equated annual rent to be charged for the proposal.
PROBLEM NO:-10
Beta Ltd. is considering the acquisition of a personal computer costing Rs. 50,000. The effective
life of the computer is expected to be five years. The company plans to acquire the same either by
borrowing Rs. 50,000 from the bankers at 15% interest per annum or by lease. The company wishes
to know the lease rentals to be paid annually which will match the loan option. The following further
information is provided to you:
1) The principle amount of the loan will be paid in five annual equal installments.
2) Interest, lease rental, principle repayment is to be paid on last day of each year.
3) The full cost of the computer will be written off over the effective life of computer on as
straight-line basis and the same will be allowed for tax purposes.
4) The company`s effective tax rate is 40% and the after tax cost of capital is 9%
5) The computer will be sold for Rs. 1,700 at the end of the 5thyear. The commission on such
sales is 9% on the sale value and the same will be paid.
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You are required:
To compute the annual lease rentals payable by Beta Ltd. which will result in indifference to the
loan option?
The relevant discount factors are as follows:
Year
1
2
3
4
5
Discount factor
0.92
`0.84
0.77
0.71
0.65
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