2010

FORE School Of
Management

Shrikant Raju 82078
Section B WMG XVII

[ MANAGEMENT OF FINANCIAL SERVICES ASSIGNMENT - 3]

SHRIKANT RAJU WMG XVII 82078
Question
ASSUME THAT AN EQUIPMENT COSTING RS.15,000 IS OFFERED ON LEASE AS WELL AS HIRE
PURCHASE BY A FINANCE FIRM. THE PERIOD OF CONTRACT IS 5 YEARS AND SALVAGE VALUE IS
ZERO.
THE EQUIPMENT IS CHARGED FOR DEPRECIATION ON A STRAIGHT LINE BASIS. IF LEASED, THE
RENT WOULD BE RS.3,750 PER YEAR FOR 5 YEARS WHILE INSTALMENT UNDER HIRE PURCHASE
AGREEMENT IS RS.3,600 PER YEAR. THE COST OF DEBT IS 10% WHILE RATE OF TAX IS 35%.
SUGGEST WHICH MODE OF FINANCING I.E. LEASE OR HIRE PURCHASE SHOULD BE ADOPTED.
Solution :
Calculating PV of total cash outflows during leasing:
Lease rental per year 3750
Cost of Debt 10%
Cost of capital: (10(1-0.35)) 6.50%
Tax benefit (@35%) : ( 3750*0.35 ) 1315.5
Actual cash outflow: (Rs. 3750 1312.5) 2437.5
PV of total cash outflow (PVIFA(10,5)): ( 2437.5 * 4.155) 10127.81

Calculating PV of total cash outflows during Hire Purchase:
Instalment per year (Rs 3600.00) 3600
Total amount paid (3600*5) 18000
Interest paid 600.00 per month 3000
Flat rate of interest: 4%
Effective rate of interest (approximation method): (5/(5+1))*2*4 ) 6.67%

Instalment Interest amount (@6.67%) Principal Depreciation (straight line
method)
3600 1005 2595 3000
831 2769 3000
646 2594 3000
448 3152 3000
236 3364 3000


SHRIKANT RAJU WMG XVII 82078

YEARS
INTEREST +
DEP
TAX
(35%) EMI
NET
OUTFLOW
DISCOUNT FACTOR
(@6.5%)
DISCOUNTED
OUTFLOWS
1 4005 1401.75 3600 2198.25
0.939 2064.085
2 3831 1340.897 3600 2259.10275
0.882 1991.759
3 3646 1275.967 3600 2324.032634
0.828 1923.948
4 3448 1206.687 3600 2393.312821
0.777 1860.377
5 3236 1132.765 3600 2467.23478
0.730 1800.787

Total (PV CASH
OUTFLOW) Hire
Purchase 9640.96

After the calculation we see that Hire purchase mode of financing is suggested as the
PV of total cash is higher Incas of leasing in comparison to Hire purchase method.
Therefore the recommendation is to go for Hire Purchase over leasing.