Term Loan and Lease Financing

Problem 4.1: The Nirmal Company is faced with the decision of whether it should purchase or lease a new
Lease versus computer. The computer can be leased on five year contract for Rs 6,000 a year or it can be
Purchase Decision purchased for Rs 25,000. The salvage value of the computer after five years is Rs 2,000. The
company uses straight-line depreciation. The discount rate applied is its after-tax cost of debt.
The company can borrow at 15 percent and has a 40 percent marginal tax rate and a 12 percent
cost of capital.
a. Calculate the cost of leasing.
b. Calculate the cost of purchasing.
c. Should the firm lease or purchase the computer?
Problem 4.2: Everest Nepal seeks to acquire the use of a machine at the lowest possible cost. The choice is
Leasing vs. owning either to lease one at Rs 6,600 annually or to purchase one of Rs 15,000. The lease payment is
decision payable at the end of the year. The company's cost of debt is 10 percent, and its tax rate is 40
percent. The machine has an economic life of five years with no salvage value. The firm uses
straight line depreciation method:
a. Calculate the present value of cost under leasing alternative.
b. Calculate the present value of cost under purchase alternative.
c. Would you lease or purchase the assets?
Problem 4.3: A Company is trying to decide between leasing and buying a new equipment. The company
Lease vs. purchase can lease the equipment for five years, making annual payments of Rs 16,378 per year or they
decision can buy the equipment for Rs 50,000. At the end of fifth year, the equipment will have salvage
value of Rs 10,000. The firm's cost of capital is 10 percent with a before tax cost of debt of 8
percent. The company uses straight-line depreciation and has a 50 percent tax rate.
Analyze whether the company should lease or buy. Use the after-tax cost of debt as a discount
factor and obtain the result using schedules.
Problem 4.4: Himalayan College needs a generator. It can either buy it for Rs 250,000 or lease it from the
Lease versus company. The lease and purchase terms are as follows:
Purchase Decision
Leasing: Himalayan College lease under a five-year lease requiring annual end-of-year
payments of Rs 62,000.
Purchasing: The generator costs Rs 250,000 and will have a five-year life. The salvage value of
generator is Rs 10,000. The investment tax credit is 10 percent. The annual maintenance
expenses are Rs 1,000 per year (which has been included in lease rent under leasing alternative).
The asset will be depreciated under straight line method for five years. The interest rate on bank
loan is 10 percent. The firm is in the 40 percent tax bracket.
a. What is the cost of leasing?
b. What is the cost of owning?
c. Should the college lease or purchase the generator?
Problem 4.5: National Hydropower Company (NHC) needs a drilling machine for construction of a tunnel.
Leasing vs. owning One alternative is to lease the machine on a 4-year guideline contract for a lease payment of
decision Rs 50,000 per year, with payments to be made at the end of each year. Alternatively, NHC could
purchase the machine outright for Rs 200,000, financing the purchase by a bank loan for the net
purchase price and amortizing the loan over a 4-year period at an interest rate of 12 percent per
year. The machine falls into the MACRS 3-year property class. It has a residual value of
Rs 20,000, which is the expected market value after 4 years, when NHC plans to replace the
machine irrespective of whether it leases or buys. NHC has a marginal corporate tax of 35
percent.
a. What is NHC’s PV cost of leasing?
b. What is NHC’s PV cost of owning? Should the machine be leased or purchased?
 c. What are the advantages of leasing over purchasing?
Problem 4.6: FFF Company wishes to acquire a Rs 100,000 multi-facet cutting machine. The machine has a
Present value and useful life of 8 years, after which there is no expected salvage value. If it were to lease finance
IRR Method
the machine over 8 years, annual lease payments of
Rs 16,000 would be required, payable in advance. The company also could borrow at a 12
percent rate. The asset falls in the 5–year property class for cost recovery (depreciation)
purposes and the company has a 35 percent tax rate.
What is the present value of cash outflows for each of these alternatives, using the after-tax cost
of debt as the discount rate? Which alternative is preferred?
Problem 4.7: TATA Company produces industrial machines, which have five-year life. TATA is willing to
Competitive lease either sell the machines for Rs 3,200,000 or to lease them at a rental that yields an after tax return
rent to TATA of 6 percent –its cost of capital. What is the company's competitive lease rental rate?
Assume straight-line depreciation, Rs 200,000 salvage value, and an effective corporate tax rate
of 40 percent.
Problem 4.8: a. The Delta Company produces industrial machines, which have five- year lives. Delta is
Competitive Lease willing to either sell the machines for Rs 300,000 or lease them at a rental that, because of
rent and lease competitive factors, yields an after-tax return to Delta of 6 percent – its cost of capital. What
versus owning is the company's competitive lease-rental rate? (Assume straight-line depreciation, zero
decision
salvage value, and an effective corporate tax rate of 40 percent.)
b. The Gamma Machine Shop is contemplating the purchase of a machine exactly like those
rented by Delta. The machine will produce net benefits of Rs 100,000 per year. Gamma can
buy the machine for Rs 300,000 or rent it from Delta at the competitive lease-rental rate.
Gamma's cost of capital is 12 percent, its cost of debt 10 percent, and T = 40 percent. Which
alternative is better for Gamma?
c. If Delta's cost of capital is 9 percent and competition exists among lessors, solve for the
new equilibrium rental rate. Will Gamma's decision be altered?
Problem 4.9: Mountain Mining Company (MMC) must install Rs 1.5 million of new machinery in its Sholu
Lease versus mine. It can obtain a bank loan for 100 percent of the purchase price, or it can lease the
purchase machinery. Assume that the following facts apply.
decision
1. The machinery, which has a useful life of 4 years, falls into the MACRS 3- year class.
2. Estimated maintenance expenses are Rs 75,000 per year, payable at the beginning of each
year.
3. The firm's tax rate is 40 percent.
4. The loan would have an interest rate of 15 percent.
5. The lease terms call for Rs 400,000 payments at the end of each of the next 4 years.
6. Under either the lease or the purchase, the company must pay for insurance, property
taxes, and maintenance.
7. The estimated residual (and salvage) value is Rs 250,000 at the end of 4th year.
What is the NAL of the lease? Should the machinery be leased or purchased?
Problem 4.10: Janakpur Industries must install Rs 1 million of new machinery in its Jaleshwor plant. It can
Lease versus obtain a bank loan for 100 percent of the required amount. Alternatively, a Jaleshwor
purchase investment banking firm which represents a group of investors believes that it can arrange for
decision
a lease financing plan. Assume that these facts apply.
1. The equipment falls in the MACRS 3-year class.
2. Estimated maintenance expenses are Rs 50,000 per year.
3. The firm's tax rate is 34 percent.
4. If the money is borrowed, the bank loan will be at a rate of 14 percent, amortized in 3 equal
installments at the end of each year.
5. The tentative lease terms call for payments of Rs 320,000 at the end of each year for 3 years.
6. Under the proposed lease terms. The lessee must pay for insurance, property taxes, and
maintenance.
 7. Janakpur must use the equipment if it is to continue in business, so it will almost certainly
want to acquire the property at the end of the lease. If it does, then under the lease terms
it can purchase the machinery at its fair market value at that time. The best estimate of this
market value is Rs 200,000, but it could be much higher or lower under certain
circumstances.
To assist management in making the proper lease-versus-buy decision, you are asked to
answer the following questions:
Assuming that the lease can be arranged, should the firm lease or borrow and buy the
equipment? Explain. (Hint: In this situation, the firm plans to use the assets beyond the term of
the lease. Thus, the residual value becomes a cost to leasing in Year 3. Also, there is no Year 3
residual value tax consequence, as the firm cannot immediately deduct the Year 3 purchase price
from taxable income)
.1 a. Rs 16,681.10
b. Rs 9,945.12
2 Cost of leasing Rs 36,455.79; Cost of owning Rs 23,973.59

3 a. Rs 156,701.28
b. Rs 139,176.36
4 a. Rs 108,125.08
b. Rs 129,838.90
5 PV (L) = Rs 67,449,
PV (P) = Rs 71,462.97
6 Rs 806,981

7 a. Lt = Rs 78,698
b. PV (L) = Rs 198,903
PV (P) = RS 198,904
c. Lt = 88,544; PV (L) = Rs 223,789
8 NAL = Rs 108,057

9 PV (L) = Rs 685.752,
PV (P) = Rs 729.956
10 PV of stock facilities = Rs 706,260
NPV of project =  Rs 55,616