Question

(b) Eir-Tel, Inc. is a telecommunication services provider looking to expand to a new territory Z. It is analyzing whether it should install its own telecom towers or lease them out from a prominent tower-sharing company X-share, Inc. Leasing out 100 towers would involve payment of €5,000,000 per year for 5 years. Erecting 100 new towers would cost €18,000,000 including the cost of equipment and installation, etc. The company has to obtain a long-term secured loan of €418,000,000 at 5% per annum. Owning a tower has some associated maintenance costs such as security, power and fueling, which amounts to €10,000 per annum per tower. The company’s tax rate is 40% while its long-term weighted average cost of debt is 6%. The tax laws allow straight-line depreciation for 5 years. Determine whether the company should erect its own towers or lease them out. [14 marks]

Answer 1

The annual cash-flows(outward) due to  the lease from Y1 - Y5( year 1 to year 5)

=>€5000000 *(1 – 0.4) = €3000000

The yearly cash-flow for the purchasing has three parts:

1. Loan repayment amount (yearly)

2.Yearly Maintenence Costs

3.Tax-related costs in maintenance, the depreciation cost & interest payable.

Cash Flow Table :

Period Number		1	2	3	4	5
Loan repayment Amount	A	41,57,546	41,57,546	41,57,546	41,57,546	41,57,546
Maintenance expenses	B	10,00,000	10,00,000	10,00,000	10,00,000	10,00,000
Depreciation expenses	D	36,00,000	36,00,000	36,00,000	36,00,000	36,00,000
Interest payable	I	9,00,000	7,37,123	5,66,101	3,86,529	1,97,978
Tax deductions	T	55,00,000	53,37,123	51,66,101	49,86,529	47,97,978
Tax relief@40(%)	t	22,00,000	21,34,849	20,66,441	19,94,612	19,19,191
The net cash flow	N	29,57,546	30,22,697	30,91,106	31,62,935	32,38,355

Where :

T = (B+D+I)

t = (0.4*T)

N = (A+B)–t

The yearly loan payback calculated on the basis of the present-day calculations i.e The payment value which is being made at the end of each year for five years to complete the loan repayment.

We can calculate it in excel by the fn: PMT wherein the :

rate = 5%

number of years(nper) = 5

and present value(PV) =-18000000

Debt-Amortisation Table :( For evaluating the interest expenses)

Using the straight-line method we calculate the depreciation which is :

€18000000/5 = €3600000

We have to deduct the tax concession(relief) from the loan repayment amount & the maintenance costs.

calculating the P.V( Present Value) of the cash outflow under the given option with the aftertax debt cost i.e

=> 3.6 % [ => as (6/100* (1-40/100)) ]

P.V(Present Value) of leasing at 3.6 percent  = €13545157

P.V(Present Value) when the purchase is at 3.6 percent  = €13950176

We observe that the lease option will have a relatively lower Present Value(P.V) of the cash outflow

Therefore that will be the preferable option.