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Q.1 XYZ ltd is in business of manufacturing 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 salvage value of Rs.100000 after the expiry of 5 Years. The purchase can be
financed by 20% loan repayable in 5 equal installments becoming due at the end of each
year. Alternatively, the machine can be taken on year end lease rental of Rs.450000 for 5
years. Advise the company which option it should choose. For your exercise, you may
assume the following.
1. The machine will constitute a separate block for depreciation purpose. The
company follows written down value method of depreciation, the rate of
depreciation being 25%.
2. Tax Rate 35% and cost of capital is 18%
3. Lease rent are to be paid at the end of year
Q.2 The following details relate to an investment proposal of the Hypothetical Industries
Ltd (HIL)
Investment outlay, Rs 180 Lakh, Useful life,4 Years, Net Salvage Value after 3 years, Rs
18 Lakh, Annual Tax relevant rate of Depreciation,40%
The HLL has two alternatives to choose from to finance the Equipment:
Alternative I: Borrow and Buy the equipment. The cost of capital of HIL is = .12,
marginal rate of tax = .35, Cost of Debt = .75per annum.
Alternative II: Lease the equipment from Hypo Leasing Ltd on a 3 year full-payout
basis @444/Rs1000 payable annually in arrears. The lease can be renewed for a further
period of 3 years at a rental of Rs.18/1000 payable annually in arrear.
Which alternative should the HIL Choose? Why?
Q.3 Taking data from question 2, assume the lease rental of Rs.35/1000 payable monthly
in advance. Compute the NAL/NPV(L).Should the HIL opt for lease financing?
Q4. Taking data from question 2, assume monthly lease payment in advance. Compute
the break even monthly lease rental. Can the HIL accept a lease quote of Rs. 35/1000 per
month payable in advance?
Lessor’s Viewpoint
Q.5 Taking data from Question 1, assume further that:1)the Lessor’s weighted average
cost of capital is 14%.Is it financially viable for leasing company to lease out the
machine?
Q.6 From the facts contained in Question 5, a) determine the minimum lease rentals at
which Lessor would break-even. Also prepare verification table. Determine the lease
rentals if the Lessor wants to earn NPV of Rs.1 lakh.
Q.7 The under mentioned facts relate to a lease proposal before the Hypo Leasing Ltd.:
The initial cost of equipment to be leased out is Rs 300 Lakhs, on which 10 % central
sales tax would be levied. At the end of the lease term after 5 years, the salvage value is
estimated to be Rs.33 Lakhs. The other cost associated with the lease proposal payable in
advance are initial direct cost = Rs.3 Lakhs and management fees=Rs 5 Lakhs. The
marginal cost of funds to the HLL is 14 % while the marginal rate of tax is 35%.What is
the breakeven rental for HLL if the tax relevant rate of depreciation is 25%.?
Q8.The HLL has under consideration a lease proposal. Its post-tax cost of fund is 14%
and it has to pay CST @ 10% of the basic price of the capital equipment in inter state
purchases. The marginal tax rate of HLL IS 35%, The details of the proposed lease are
given below:
• Primary Lease period 3 Years
• Tax relevant depreciation, 40% on written down value.
• Residual value,8% of the original cost
o If the monthly lease rentals are collected in advance, what is the minimum
lease rental HLL should charge for per Rs1000 for the lease?
o What is the minimum monthly lease rental for a lease proposal costing
Rs.660 Lakhs (Including 10% CST)
Q10. The pre tax cost of capital of the hypothetical Leasing Ltd. Is 20%.Its expected pre-
tax return on investment is 23%.Assuming a non-cancellable lease period of five years,
determine the lease rental per Rs.1000 so as to give to the HLL its expected income
Quarterly Rental
Q11.For the facts relating to HLL, in Question No.10, compute the quarterly rental to
earn a per tax return of 23%.
Advance Rental
Q12. For the facts in Question 10 assume the rental is paid in advance, that is in the
beginning of each year and compute the annual lease Rental.
1. Stepped Rental
Q.13. The pre tax expected rate of return for the hypothetical leasing Ltd. is 24% for a
five year non- cancellable lease. The annual lease rental would be stepped at 10% over
the period. Compute the lease rental per Rs.1000.
2. Deferred Rental
Q.14 Considering the facts of Question 13, compute the lease rental as deferred for the
first two years.
3. Bell-Shaped Rental
Q15 Considering the facts of Question 13, the lease rental will be stepped by 25% and
then by 40% and subsequently stepped down in the reverse order in the fourth and the fist
year. compute the lease rental per 1000.
The company uses the straight line method of depreciation and pays 50% of tax.
The management of HCL approaches you for advice.