Module-

LEASING AND HIRE PURCHASE

CALCULATION OF LEASE RENTALS

P.1
Consider the following information of Hindustan Leasing Ltd. (HLL)
Pre-tax rate of return 12%, lease term – 5 years and cost of the equipment Rs.1,000 lakh.
Calculate i) Lease rental in arrears, ii) Lease rental in advance, iii) Quarterly lease rental, iv) Half yearly lease
rental, v) Monthly lease rental vi) Lease rental if deferred for first two years vii) if stepped at 10% viii) Bell
shaped (Stepped up by 25% and then by 40% and subsequently stepped down in the reverse order in the 4 th and
5th year.

P.2
The following data are furnished by ABC Leasing Ltd.
Investment cost Rs.500 lakh, primary lease term 5 years, estimated residual value after the
primary period Nil and pre-tax required rate of return 24%.
Calculate annual lease rentals under the following rental structures:
a) Equated b) Stepped (an annual increase of 15%) c) Ballooned (annual rental of Rs.80
lakh for years 1 – 4) and d) Deferred (2 years deferment period).

P.3 XYZ Ltd. has taken a plant costing Rs.20 cr on lease basis. The lease arrangement is in
the form of a leveraged lease. The leasing company PQR Ltd. is equity participant and ABC
Ltd. is loan participant. They fund the investment in the ratio of 2:8. The loan from ABC Ltd.
carries a fixed rate of interest of 19%, payable in 6 equated annual installments. The lease
rental is payable in arrears for 6 years.
a. Compute equated annual installment payable to ABC Ltd.
b. Compute lease rental receivable from by PQR Ltd. if pre-tax yield is 25%.

P.4 The Avon Leasing Ltd. (ALL) has structured a leveraged lease with an investment cost of
Rs.20 crore. The ALL is the equity participant and Innovative Bank Ltd. (IBL) is the loan
participant. They fund the investment in the ratio of 2:8. The loan from IBL carries a fixed
rate of interest of 19% payable in six equated annual installments. The lease term is 6 years.
With lease rental of Rs.700 /Rs.1,000 payable annually in arrears.
a. You are required to compute the cash flow from the point of view of ALL
b. If the lease rent is unknown, and ALL’s pretax yield is 25%, what is the minimum
lease rent that must be quoted?

P.5 From the given facts relating to the Hypothetical Leasing Ltd. calculate the annual rentals
under the following rental structure for the 6 year period:
i) Equated, ii) Stepped (annual increase of 12%), iii) Ballooned (annual rental of Rs.15 lakh
for year 1 and 2) iv). Deferred (deferment period of 1 year)
Investment cost Rs.96 lakh, Primary lease term 3 years, estimated residual value after the
primary period is nil and Pre-tax required rate of return 22%.
Assume that the lease can be renewed for an additional period of 3 years (secondary lease
period). The lease rental for the secondary period will be 5% of the rental charged during the
primary period.
Solution:

P.6 Assume the Hypothetical Textiles Ltd. (HTL), a 100% export-oriented firm, is
considering a capital investment of Rs.400 lakh to modernize its plant. An option available
to HTL is to lease the required equipment from the HTL structured as a 6 year non-
cancellable finance lease with equated annual rental. Assuming further, no salvage value and

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20% marginal cost of capital of HTL, what is the maximum lease rental it will be willing to
pay to HTL?

P.7 Under the car finance plan of Tata Finance Company a self employed professional can
borrow upto Rs.3 lakh repayable by 12 monthly installments in arrears calculated at a flat
interest rate of 12% p.a.
i. Calculate the monthly repayment on a loan amount of Rs.2.50 lakh and find the APR
(Annual Percentage Rate) on the transaction.
ii. Construct a loan repayment schedule showing the loan outstanding after each
repayment using ERI method.
MBA(GUG)April2000

P.8 The Hindustan Manufactures Ltd. (HML) has under consideration the purchase of an
equipment from the Delhi-based Hypothetical Suppliers Ltd. (HSL) at a cost of Rs.150 lakh
subject to 4% sales tax. As an alternative, the equipment can be leased from the Avon
Leasing Ltd. (ALL) on the basis of a 5 year quote of Rs.26.75 ptpm payable at the end of
every month. The ALL is required to pay a 4% sales tax on the quoted lease rental. Show
the payable lease rental.

P.9 Star Trac leasing company will lease a piece of equipment which costs it Rs.80,000 to
purchase. Quarterly lease payments of Rs.4,400 in advance are required for 5 years. At the
end of the lease, Star Trac estimates the asset will have a residual value of Rs.20,000. What is
the implicit return to the lessor embraced in these returns. What do you understand from these
lease terms? What are your suggestions to the lessor?
MBA-MFS-(GUG)- 2002(I)

P.10 Under a hire-purchase deal structured by the Hypothetical Finance Ltd. (HFL) for the
Hypothetical Industries Ltd. (HIL), the flat rate of interest is 15%. The HIL is required to
make a cash down payment of 25% and the repayment of the loan is to be made in 36 equated
monthly installments. On the assumption of payment of installment in a. advance b. arrear,
compute the ERI/APR for the plan.

P.11 Under a purchase deal structured by the Hypothetical Finance Ltd. (HFL) for the
Hypothetical Industries Ltd. (HIL), the HFL offers to provide 100% finance to the HIL at a
flat rate of interest of 13%. The HIL has to invest 20% of the investment cost as fixed
deposit with the HFL during the hire-purchase period of three years at 15% compounded
monthly. The repayment has to be made in 36 monthly installments in arrear. Compute the
ERI/APR on an investment cost of Rs.1,000.

`FINANCIAL EVALUATION

P.1 Alfa Ltd. is thinking of installing computers. Decide whether the computers are to be
purchased outright (through 14% borrowing) or to be acquired on lease basis. The company
is in the 50% tax bracket. The other data available are:
Purchase of computers:
Purchase price Rs.20,00,000
Annual maintenance (to be paid in advance) Rs.50,000 per year
Expected economic useful life 6 years
Depreciation (for tax purposes) SLM
Salvage value Rs.2,00,000
Payment of loan: 6 year-end equal installments of Rs.5,14,271
Leasing of computers:

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 Lease charges (to be paid in advance): Rs.4,50,000
Maintenance expenses to be borne by lessor

on lease basis because it has savings of Rs.64,822 (11,51,622 – 10,86,800).

P.2 ABC Machine Tool Co. Ltd. is considering the acquisition of a large equipment to set up
its factory in a backward region for Rs.12,00,000. The equipment is expected to have an
economic useful life of 8 years. The equipment can be financed either with an 8 year term
loan at 14% interest, repayable in equal installments of Rs.2,58,676 per year, or by an
equivalent amount of lease rent per year. In both cases, payments are due at the end of the
year. The equipment is subject to the straight line method of depreciation for tax purposes.
Assuming no salvage value after the 8 year useful life and 50% tax rate, which of the
financing alternatives should it select?

P.3 The Controller of General Electronics Corporation of India Ltd. has been analyzing the
firm’s policy regarding computers, which are now being leased on a yearly basis on rental
amounting to Rs.1,00,000 per year. The computers can be bought for Rs.5,00,000. The
purchase would be financed by 16% loan repayable in 4 equal annual installments.
On account of rapid technological progress in the computer industry, it is suggested that a 4
year economic life should be used, instead of the 10 year physical life. It is estimated that the
computers would be sold for Rs.2,00,000 at the end of 4 years. The company uses the SLM
of deprecation. Corporate tax rate is 50%.
a. Comment on whether the equipment should be bought or leased?
b. Analyse the financial viability from the point of view of the lessor, assuming 14%
cost of capital
c. Determine the minimum lease rent at which the lessor would break even
d. Determine the lease rent which will yield an IRR of 16% to the lessor.

P.4 NBT Ltd. is thinking of installing a computer. It is to decide whether the computer
should be acquired on lease, or be purchased through borrowings at a 12% rate of interest
payable at the end of the each year. Principal is due for repayment after 10 years. The
following data has been collected for the purpose:
Purchase of Computer:
Purchase price Rs.40,00,000
Annual maintenance Rs.50,000 (to be paid in advance every year)
Life of the computer 10 years
Depreciation 15% p.a. on WDV basis
Salvage value Rs.4,00,000
Leasing of Computer:
Initial lease payment (Advance) Rs.4,00,000
Lease rent Rs.7,00,000 (payable in advance every year for 10 years)
Maintenance expenses to be borne by the lessor
You are required to advise NBT Ltd. as to whether it should purchase the computer or
acquire it on lease basis assuming that it does not pay any tax.

P.5 HCL Ltd. is considering acquiring an additional computer to supplement its time-share
computer services to its clients. It has two options:
i) To purchase the computer for Rs.22,00,000 by borrowing at 16% which is repayable in 3
instalments of Rs.8,52,000, Rs.11,22,000 and Rs.9,86,000. ii) To lease the computer for 3
years from a leasing company for Rs.5,00,000 annual lease rent plus 10% of gross time-share
service revenue. The agreement also requires an additional payment of Rs.6,00,000 at the
end of the third year. Lease rents are payable at the year end and the computers are reverted
to the lessor after the contract period. The company estimates that the computer under review
will be worth Rs.10 lakh at the end of the third year.

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 Years 1 2 3
Forecast Revenue (Rs.) 22,50,000 25,00,000 27,50,000
Annual operating costs (excluding depreciation and lease rent of computer) are estimated at
Rs.9,00,000 with an additional Rs.1,00,000 for start-up and training costs at the beginning of
the first year. Tax rate is assumed to be 50%.

P.6 XYZ Ltd., manufacturing steel utensils is planning to diversify and add a new product
line. The firm either can buy the required machinery or get it on lease basis, the details of
which are given below.
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% loan repayable in 5 equal annual installments 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 company on the option it should choose. For your exercise, you may assume the
following:
The machine will constitute a separate block for depreciation purposes. The company follows
WDV method of depreciation, the rate of depreciation being 25%. Corporate tax rate is 35%
and cost of capital is 13%. Maintenance expenses estimated at Rs.30,000 p.a. are to be borne
by the lessee. Also find out financial viability of leasing for a leasing company assuming
weighted average cost of capital 14%.

P.7 An industrial unit desires to acquire a diesel generating set costing Rs.20 lakh which has
an economic life of 10 years and at the end of which the asset is not expected to have any
residual value. The unit is considering the alternative choices of taking the machinery on
lease or purchasing the asset outright by raising a loan. Lease payments of Rs.2,95,902 are to
be made in advance and the lessor requires the asset to be completely amortised over its
useful period.
The cost of debt is worked out at 16% p.a. The lender requires the loan to be re-paid in 10
equal annual installments becoming due at the beginning of the first year. Average rate of
income tax is 50%. It is expected that the operating costs would remain the same under both
methods. The firm follows straight line method of depreciation and the same is accepted for
tax purposes. As a financial consultant, indicate what your advice will be.

P.8 The following data are available on the lease portfolio of Super Financial Services.
Block-1 Block-2
Rate of depreciation 25% 40%
WDV as on 1-4-2018 500 lakh 290 lakh
Investment before 30-10-2018 225 lakh 150 lakh
Investment after 30-10-2018 50 lakh 75 lakh
Sale of assets resulted in a realization of Rs.125 lakh of which Rs.90 lakh pertain to block-2.
Taking into account the tax rate, depreciation rate and the relevant provisions of the income
tax Act, compute the depreciation tax shield for the assessment year 2019-20 and for the
assessment year 2020-21.
MBA(GUG)-I-2001

P.9 Welsh Ltd. is faced with a decision to purchase or acquire on lease a mini car. The cost
of the car is Rs.1,26,965 with useful life of 5 years. The mini car can be obtained on lease by
paying equal lease rentals annually. The leasing company desires a return of 10% on the
gross value of the asset. Welsh Ltd. can obtain 100% finance from its regular banking
channel at annual interest rate of 15% repayable in five annual equal installments. The
effective tax rate of the company is 40%. For the purpose of taxation, it is to be assumed that
the asset will be written-off over a period of 5 years on straight line basis.
a. Advise Welsh Ltd. about the method of acquiring the car
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b. What should be the annual lease rental to be charged by the leasing company to match
the loan option?
MBA-VTU-III Sem. MBFS-Dec./Jan.-2007-08