Question

Joseph’s Engineering Ltd need to acquire new equipment and it can either take a loan or have a lease option. The loan funds of $100 000 at 8.2% p.a. after tax, compounded semi-annually for 2 years. The company has three directors in the business and they pay individual income tax at an average rate of 35%. Inland Revenue Department (Tax office) allows depreciation at the rate of 50% p.a. on this equipment. Advise the company which is the better deal, the loan or a 2 year lease with four equal payments of $26,674 starting with the first payment at the signing of the contract. Assume that corporate tax rate is 28% for simplicity’s sake the tax benefits from each lease payment and the tax benefits forgone for depreciation are received without time lag in each half-year period. Required: a. Which method of financing would you recommend? Why? (Hint: Show analysis of cash flow) b. List potential benefits associated with leasing?

Answer 1

Solution:-

• if there should be an occurrence of credit ,tax is computed on net benefit ,
• net benefit = gross profit- interest - deterioration
• if there should be an occurrence of advance ,the intrigue paid and devaluation charge will decrease the taxation rate i.e advantage in impose
• if there should be an occurrence of rent ,benefits got in type of duty on rent sum is forego on by devaluation.

option 1	loan
intrest rate	8.2%	half yearly
		0	6months	12months	18 months	24months
loan		$1,00,000				(1,00,000)
interest			$2,100	$2,100	$2,100	$2,100
Depreciation				($50,000)		($50,000)
Tax benefits (35%)			=2,100 * 35% = $735	= (2100 + 50,000) * 35% = $18,235	= 2100 * 35% = $735	=( 2100 + 50,000) * 35% = $18,235
Net cash flow			= 2100 - 735 = $1,365	= 18,235 - 2,100 = $16,135	= 2,100 - 735 = $1,365	= 18,235 - 2,100 = $16,135
Total cash flow			=( 16,135 + 16,135)- (1,365 + 1,365) = 32270 - 2730 = $29,540
Option 2	Lease
		0	0months	6months	12months	18months
Lease amount			$26,674	$26,674	$26,674	$26,674
Depreciation			$0	$0	$0	$0
Tax benefits (35%)			$0	$0	$0	$0
Net cash flow			$26,674	$26,674	$26,674	$26,674
Total cash flow			= 26,674 + 26,674 + 26,674 + 26,674 = $1,06,696

• organization ought to lean toward the advance alternative here.

(b).Equipment leasing is most beneficial to companies when:-

• Constrained term of utilization ,(not utilized for long haul) .
• Shot of getting to be respondent quick.
  
• Income isn't ideal.
• Required money for long haul obligation installment .
• Assurance of monetary record.
• Need tax break from rent installment.