Assignment Questions

Leasing

Q- 1- The controller of General Electronics Corporation of India Ltd. has been

analyzing the firms policy regarding the 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 instalments.
On account of the rapid technological progress in the computer industry, it is
suggested that a 4 year economic life should be used, instead of the 10year
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 straight line method of depreciation. Corporate tax rate is 50
per cent.
(a) Comment on the equipment should be bought or leased.
(b) Analyse the financial viability from the point of view of lessor, assuming 14
per cent coat 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.
Q 2- Mini Case
Teddy Bear Ltd. is in the business of making toys of different ranges. Presently,
teddy bear has one manufacturing plant having production capacity of 30,00,000
toys annually. They are sold through registered dealers in India who take delivery of
toys directly from the factory situated in Noida. Teddy bear does not incur any
transport cost.
The demand for toys has shown tremendous growth in recent years. The vice
president marketing, Sanjay Khanna, has submitted a proposal to the CEO, Vikrant
Kumar Singh, to expand the production capacity of Teddy Bear to 40,00,000 toys.
The CEO directs the Vice President, Manufacturing, Virender Kumar Rathi, to put a
proposal regarding the availability of the required equipment for the expansion of
the plant. A survey shows that the machinery is available for Rs 12.5 crore having a
useful life of five years and no salvage. Assume straight line depreciation for tax
purposes. It also shows that there are two alternatives to finance the proposal. The
equipment can be bought and financed by borrowing from the Udharwala Financial
services Ltd. at 10 per cent interest. The equipment can be alternatively taken on
lease from XYZ Ltd at Rs 3.5 Crore annual lease rental. The XYZ would bear the
associated taxes, insurance and maintenance costs amounting to Rs 60,00,000
annually.
Required:- Vikrant Singh engages you as a financial consultant to advise him on the
choice of the funding alternatives. Should Teddy Bear buy the equipment through

borrowing or acquire it on lease? What advice would you give and why? Assume
thirty percent corporate tax.