Chapter 3

Lease Financing

1. A manufacturing company wishes to acquire three heavy trucks that cost Rs 100,000 in total. A
leasing company has offered to lease the trucks to a manufacturing company for a total Rs 25,000 per
year for each of the five years with lease payment payable in advance. To evaluate this option,
manufacturing company depreciated the trucks via straight-line depreciation over their five-year
normal recovery period and 8 percent investment tax credit is in effect. The marginal tax rate
applicable is 40 percent and before tax cost of debt is 15%. If the trucks are leased, the ITC will be
passed on to the leasing company. Should the manufacturing company lease of purchase the trucks?
2. The Nepal Transportation Company (NTC) has decided to acquire a new truck. One alternative is to
lease the truck on a 4-year guideline contract for a lease payment of Rs 10,000 per year, with
payments to be made at the beginning of each year.. Alternatively, NTC could purchase the truck
outright for Rs 40,000, 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 10 percent per year, installment is to be
paid at the beginning of the year. Under the borrow to purchase arrangement, NTC would have to
maintain the truck at a cost of Rs 1,000 per year, payable at year end. The truck falls into the MCRCS
3-year class. It has a residual value of Rs 10,000, which is the expected market value after 4 years,
when NTC plans to replace the truck irrespective of whether it leases or buys. NTC will get 5%
investment tax credit if purchase alternative is chosen. NTC has a marginal rate of 40 percent.
a. What is the NTC’s PV cost of leasing?
b. What is the NTC’s PV cost of owing?
c. Should the truck be leased or purchased?
3. a) The Chirta Company produces industrial machines, which have five- year lives. Chitra is willing to
either sell the machines for Rs 30,000 or lease them at a rental that, because of competitive factors,
yields an after-tax return to Chitra of 6 percent – its cost of capital. What is the company's
competitive lease-rental rate? (Assume straight-line depreciation, zero salvage value, and an effective
corporate tax rate of 40 percent.)
b) The Sohan Machine Shop is contemplating the purchase of a machine exactly like those rented by
Chitra. The machine will produce net benefits of Rs 10,000 per year. Sohan can buy the machine for
Rs 30,000 or rent it from Chitra at the competitive lease-rental rate. Sohan's cost of capital is 12
percent, its cost of debt 10 percent, and T = 40 percent. Which alternative is better for Sohan?
c) If Chitra's cost of capital is 9 percent and competition exists among lessors, solve for the new
equilibrium rental rate. Will Sohan's decision be altered?