Lease Rentals

Expected Cash Flow

NPV

1
122,720
79,768
63,814

2
127,629
82,959
66,367

3
132,734
86,277
69,022

4
138,043
89,728
71,783

1
118,000
76,700.0
15,340.0
76,700.0

63,814.4

66,367.0

69,021.7

71,782.5

Rs. 321,867

20% Probablity
Expected CF
Expected Cash Flow
Total expected CF
NPV

0
118,000
76,700
61,360

Rs. 272,833.44

Operating cost has not been taken in this case . As per the question , Op ex will be borne by lessee. This no longer remains a d

5
Inflation
Tax rate
WACC

ee. This no longer remains a differentiaing factor in O/FL/buy.

4%
35%
14%

Lease Rentals
Expected Cash Flow
NPV

1
122,720
79,768
63,814

2
127,629
82,959
66,367

3
132,734
86,277
69,022

1
118,000
76,700.0
15,340.0
76,700.0

63,814.4

66,367.0

69,021.7

35000

35000

35000

Rs. 321,867

20% Probablity
Expected CF
Expected Cash Flow
Total expected CF
NPV
NPV
Buy Outrightly

0
118,000
76,700
61,360

Rs. 272,833.4 With 4% Inflation

Rs. 255,485.4 With 0% inflation.

Year
Initial Investment
Depriciation Tax Shield
Expecteed Salvage Value
Net CF
Expected CF @ 80%

0
-500000

-500000
-400000

35000
28000

35000
28000

35000
28000

Year
Initial Investment
Depriciation Tax Shield
Sale of Asset
Net CF
Expected CF @ 20%

0
-500000

-500000
-100000

35000
400000
435000
87000

0
0

0
0

Total Expected CF

-500000

115000

28000

28000

NPV

-246536.43

Therefore: Buy outrightly.

With 0% inflation the buy outrightly is s

4
138,043
89,728
71,783

5
Inflation
Tax rate
WACC

4%
35%
14%

Whenever depriciation tax shield is calculated for tax purposes in a capital budgeting prob
a leasing problem, Salvage value will not be considered for calculating the Depriciation am
However the expected salvage value shall be considered as a cash inflow at the end of th
with tax implications.

71,782.5

35000
35000
28000

35000
195000
230000
184000

0
0

0
0

28000

184000

erefore: Buy outrightly.

th 0% inflation the buy outrightly is still more profitable.

poses in a capital budgeting problem or in

or calculating the Depriciation amt.
d as a cash inflow at the end of the project

Year
Initial Investment
Lease rental Paid
Tax shield on Rent
Loss on Dep tax shield
Foregone Salvage Value
Net CF
Expected CF @ 80%
In case lease is not renewed
Year
Initial Investment
Lease rental Paid
Tax shield on rent
Loss of Dep Tax shield
Net CF
Expected CF @ 20%
Total Expected CF
Post Tax cost of Borrowing
NPV

0
500000
-75000
26250

-75000
26250
-35000

-75000
26250
-35000

-75000
26250
-35000

-75000
26250
-35000

451250
361000

-83750
-67000

-83750
-67000

-83750
-67000

-83750
-67000

-35000
-195000
-230000
-184000

0
500000
-75000
26250

-75000
26250
-35000
-83750
-16750

-75000
26250

-75000
26250

-75000
26250

-48750
-9750

-48750
-9750

-48750
-9750

0
0

-83750

-76750

-76750

-76750

-184000

451250
90250
451250
5.85%
125918.40
Rs. 39,301.50

Assume prob of sub lease is 0

Assume contract is getting renewed,p=.8
Comparitive table

Inflation
Tax rate
WACC
borrowing cost

4%
35%
14%
9%

In FL Vs Buy decisions , the expexcted salvage value is discounted at lesee's CoC of the
business and NOT at the post tax cost of borrowing , because there is a higher risk
and uncertainity associated with the expected salvage values getting materialsed.
Also in OL Vs Buy comparisions the expected salvage value gets discounted at lesee's
CoC.

Year
Initial Investment
Lease rental Paid
Tax shield on Rent
Loss on Dep tax shield
Foregone Salvage Value
Net CF
Expected CF @ 80%
In case lease is not renewed
Year
Initial Investment
Lease rental Paid
Tax shield on rent
Loss of Dep Tax shield
Net CF
Expected CF @ 20%
Total Expected CF
Post Tax cost of Borrowing
NPV

Year
Salvage Value
CoC
NPV @ 80% Prob
Year
Savage Value
NPV of salvage Val
Expected NPV of Salvage Val

0
500000
-75000
26250

-75000
26250
-35000

-75000
26250
-35000

-75000
26250
-35000

-75000
26250
-35000

-35000

451250
361000

-83750
-67000

-83750
-67000

-83750
-67000

-83750
-67000

-35000
-28000

0
500000
-75000
26250

-75000
26250
-35000
-83750
-16750

-75000
26250

-75000
26250

-75000
26250

-48750
-9750

-48750
-9750

-48750
-9750

0
0

451250
5.85%
206939.91
Rs. 156,702.09

-83750

-76750

-76750

-76750

-28000

1
0

2
0

3
0

4
0

5
-195000

451250
90250

14%
Rs. -81,021.51
0

-70175.4
Rs. -151,196.95

-101277
1
-400000

Assume prob of sub lease is 0

Assume contract is getting renewed,p=.8
Comparitive table

Inflation
Tax rate
WACC
borrowing cost

FL is a better descion than buying.

Do FL vs OL separetely

4%
35%
14%
9%

Indirectly FL is better than OL.