Module08Tutorial - September 2003 FIN2101 BUSINESS FINANCE...

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September 2003 FIN2101 BUSINESS FINANCE II MODULE 8 - ANALYSIS OF LEASES QUESTION 1 Source: Peirson, Bird, Brown and Howard 1995, Business Finance , 6 th edn, McGraw-Hill, Sydney, pp. 631-2. Ibus Ltd is considering the installation of a new computer. Because of uncertainty as to its future computing requirements and the prospect of advancements in computing technology, it is evaluating the acquisition of the computer by either purchasing it, or leasing it under a contract that includes a cancellation option. Information relevant to the company’s evaluation is as follows: Purchase: The purchase price of the computer is $300 000 and it can be depreciated at a rate of 15% of the purchase price per annum, straightline. Ibus Ltd plans to operate the computer for a maximum of 5 years. The computer’s disposal value at the end of 5 years is estimated to be $50 000. Lease: The annual lease payments would be $90 000, payable at the beginning of each year. The lease can be cancelled by Ibus Ltd at any time without incurring any penalty payment. The company income tax rate is 30% and the company pays tax in the same year. The required rate of return on the investment is 20% per annum and the after-tax cost of an equivalent loan is 10% per annum. Should Ibus Ltd purchase or lease the computer? QUESTION 2 BMC Plastics Ltd has decided to acquire a new pressing machine and is trying to decide between the leasing and buying alternatives. The machine can be purchased from the manufacturer for a delivered price of $85 000. The machine will be depreciated over a 10 year period to a zero salvage value although the firm estimates that it could be sold for a minimum of $5 000 at the end of the 10 years. Alternatively, the manufacturer has offered a financial lease at $11 000 per year for the 10 years, with all operating, maintenance and insurance expenses to be borne by the lessee. Lease payments are to be made in advance. The firm's risk-adjusted discount rate is 15% per annum, its before-tax interest rate on long- term debt is 11.43%, all depreciation is straightline, and the tax rate is 30%. All tax effects would be realised in the same year. Which financing alternative would you recommend? (Round all discount rates to the nearest whole percentage, ie 54.12 = 54%, 54.86 = 55%).
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September 2003 QUESTION 3 Amalgamated Pulp Limited has decided to acquire a $300 000 pulp quality control device which has a useful life of 7 years, after which no salvage value is expected. Depreciation is allowable for tax purposes at the rate of 20% of the original price. The company is trying to determine whether it is better to purchase the device or to lease it.
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Module08Tutorial - September 2003 FIN2101 BUSINESS FINANCE...

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