Question

Optex Limited has decided to go for an equipment costing Rs. 60 million. Optex is considering two alternatives: (i) leasing the equipment, and (ii) borrowing and purchasing the equipment. GT capital is willing to lease the equipment to Optex for an annual lease rental of Rs.16 million for 5 years, the lease rental being payable in arrears. There is a management fee of Rs.1 million payable on signing the lease contract. The tax relevant depreciation rate on the equipment is 25 percent as per the WDV method. The net salvage value of the equipment after five years is expected to be Rs.14 million. Optex has an effective tax rate of 30 percent and its post- tax cost of debt is 7 percent. What is the net advantage of leasing (NAL) for Optex?

Answer 1

		In Million
		0	1	2	3	4	5
1	Cost of plant	60
2	Management fee	-1
3	Tax shield onManagement fee	0.3
4	Depreciation		15	11.25	8.438	6.328	4.746
5	Loss of depreciation tax shield		-4.5	-3.375	-2.531	-1.898	-1.424
6	Lease payment		-16	-16	-16	-16	-16
7	Tax shield on leasepayment		4.8	4.8	4.8	4.8	4.8
8	Loss of salvage value						-14
9	Cash flow of lease (1) + (2) + (3) + (5)+ (6) + (7) + (8)	59.3	-15.7	-14.575	-13.731	-13.098	-26.624
10	Present value factors	1	0.934579	0.873439	0.816298	0.762895	0.712986
11	PV Factor	59.3	-14.6729	-12.7304	-11.2086	-9.9924	-18.9825
	NAL of leasing	-8.2868