Question

1. Fahad Ltd. is a manufacturing company involved in manufacturing plastic products. It has received orders from a foreign company to manufacture plastic bags and disposable cups and which the company considers it as a positive sign for growth in the future. The company’s existing machinery will not be sufficient enough to produce for the present demand and to meet the foreign order. Two options are available (1) to lease a machinery or (2) buy a new machinery using bank loan.
If the company takes the machinery for lease it has pay a lease rent of RO. 120,000. All the expenses for the maintenance of the machinery will be borne by the Fahad ltd. If they decide to buy the machinery they have to borrow the required money from the bank at the rate of 16 % p.a to purchase the machinery. The cost of the machinery is 485,000 with a scrap value of OMR 10,000. The money borrowed will be paid in equal instalments in 5 years inclusive of principal and interest at the end of each year. The principal amount to be paid each year would be: OMR 97,000 each year. The machinery would be depreciated on a straight line basis (with residual value). The Present value is taken at 16%
A) If the company decides to take the machinery on lease. Advise the company whether it is better to pay the lease rent a) In the beginning of each year or b) at the end of the year with suitable calculations.
B) Do you advise them on buying the machinery or leasing the machinery? Give your reasons with suitable calculations

Answer 1

Answer A)

If company is decided to take machinery on lease, It is better to pay lease rent always at the end of the year. The Present Value Factor effect the value of payment as follows:-

Year	PVF @16%	If Pay in Begnning (B)	If Pay at End (E)	Present Value (B)	Present Value (E)
0	1	120,000.00	-	120,000.00	-
1	0.862068966	120,000.00	120,000.00	103,448.28	103,448.28
2	0.743162901	120,000.00	120,000.00	89,179.55	89,179.55
3	0.640657674	120,000.00	120,000.00	76,878.92	76,878.92
4	0.552291098	120,000.00	120,000.00	66,274.93	66,274.93
5	0.476113015	-	120,000.00	-	57,133.56
Value of Payment	455,781.68	392,915.24

Hence we can say that the payment made at the end shall be more beneficial for the company.

Answer B)

As per the given below calculation we can reach at the point where we decide that taking Machine of lease is more beneficial then the Buying of Machinery. As per calculation Buying Machine is more expensive in any way whether the lease rent paid in start or last of the month. Calculation is as follows:-

Year	Principal Amount	Repalyment	Outstanding	Interest	Depreciation	Total	PVF @16%	Present Value
0	0	0	485000					0
1	485000	97000	388000	77600	95000	172600	0.862069	148793.1
2	388000	97000	291000	62080	95000	157080	0.743163	116736.03
3	291000	97000	194000	46560	95000	141560	0.640658	90691.5
4	194000	97000	97000	31040	95000	126040	0.552291	69610.77
5	97000	97000	0	15520	95000	110520	0.476113	52620.01
5						-10000	0.476113	-4761.13
Present value of Payment	473690.28