Lesse Evaluation Problems

Problems on Lease Evaluation: Lessor Perspective
Example 1:
Cost of equipment = ₹ 800000

Lease management fee= 2 % of the cost
Primary lease period 5 years
Secondary lease period 3 years (6 to 8 years)
Secondary period lease rentals = 1000 per annum in advance
Transfer price= 1% of the equipment cost
Capital structure equity 30% of the capital structure and 20% is its cost of
equity; debt is 70% of the capital structure and its cost is 17%.
Depreciation rate is 33.3333%
Tax rate of lessor 50%
Calculate breakeven lease rentals for lessor to fix the minimum lease rentals for
this equipment?
Example 2:
Everlease Company (ELECO) typically writes five year leases with rentals
payable
annually in arrears. The following information is available about a lease under
review:
– Equipment Cost : Rs.33 lakh (inclusive of CST @ 10%)
– Salvage Value after 5 Years : 10% of the original cost
– Initial Direct Cost : Rs.0.3 lakh (front ended)
– Management Fee : Rs.0.5 lakh (front ended)
The cost of funds to ELECO is 14% and the marginal rate of tax is 46%.
Calculate the break even rental for ELECO assuring a tax relevant rate of
depreciation of 25%?
Problems on Lease Evaluation: Lessee Perspective
XYZ Ltd is in the business manufacturing steel bars. The firm is planning to
diversify and add new product line. The firm either can buy the required
machinery or get it on lease.
The machine can be purchased for Rs15,00,000. It is expected to have a useful
life of five (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 five (5) equal
annual instalments (including 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 firm, which option it should take up.
1) The machine will constitute a separate block for depreciation purpose.
The firm follow written down value (WDV) method of depreciation , the
rate of depreciation is being 25 per cent .
2) The tax rate is 35 per cent and the cost of capital is 18 per cent
3) Lease rentals are paid at the end of the year.
4) Maintenance expenses are estimated at Rs 30,000 per year are to be
borne by the lessee.
Illustration 2
Royal Ceramics Limited is considering investment in a balancing equipment
about which the following information is available:
The equipment costs Rs.41.6 lakh inclusive of central sales tax at 4 percent.
The acquisition will be funded through a mix of term loan and own funds in the
ratio of 3:1. The loan carries a rate of interest of 18% p.a., and is repayable in
five equal annual instalments.
The planning horizon for such investments is 5 years. After 5 years, the
equipment is expected to fetch a net salvage value of Rs.4 lakh.
The tax relevant rate of depreciation is 25%.
The investment is expected to generate an incremental EBDIT (Earnings Before
Depreciation, Interest, and Taxes) of Rs.35 lakh in year 1, Rs.20 lakh in year 2
and Rs.12 lakh from years 3 through 5.
The commercial bank which has agreed to finance the investment has recently
informed the company that on account of a temporary resource crunch, the loan
can be disbursed only after six months. The equipment is, however, urgently
required for de-bottlenecking its production process. Therefore, the company
decides to evaluate the following options:
– Finance the acquisition through a six-month intercorporate loan at a
cost of12% per semi-annual period and liquidate the liability utilizing the bank
loanmade available six months later.
– Lease the equipment.
The company has received an offer from Classic Leasing Limited, the terms of
which are as follows:
– Primary lease period : 5 years
– Secondary lease period : 3 years
– Management fee : 1% of investment cost
– Annual rental During primary period : Rs.294/Rs.1,000
During secondary period : Rs.36/Rs.1,000
The lease rentals are payable annually in arrears, but the management fee is
payable immediately on signing the lease. The lease rentals are subject to a local
sales tax of 4%. The leasing company is not entitled to the concessional CST
and has to pay sales tax @ 10% on the cost of the equipment.
Royal Ceramics has an explicitly stated target debt-equity ratio of 2:1. The
marginal costs of debt and equity are 18 percent and 22.45 percent respectively.
The marginal rate of tax is 46 percent including surcharge.
Based on economic considerations, which alternative would you recommend?

Lesse Evaluation Problems

Uploaded by

Copyright:

Available Formats

Lesse Evaluation Problems

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Lesse Evaluation Problems

Uploaded by

Copyright:

Available Formats

Problems on Lease Evaluation: Lessor Perspective

Cost of equipment = ₹ 800000

You might also like