Question

1) The lavish carpet manufacturing co. has decided to acquire a new machine that has an economic life of 10 years, with no residual value. The machine can be purchased for $75,000 and the supplier is willing to advance $45,000 of the purchase price at 12 percent. The loan is to be repaid in equal instalments over 10 years. Lavish Carpet pays 40 percent corporate income tax and can claim 20 percent capital cost allowances on the purchased asset. It expects to negotiate a further $30,000, 10-year loan with a financial institution at 14 percent interest thereby financing any purchase entirely through debt. Meanwhile midland leasing ltd. has also offered to make the equipment available under a 10-year financial lease. Lease payments of $11,200 are to be paid at the end of each year. How should the asset be acquired?

Answer 1

Answer : Asset should be leased

Explanation :

In order to decide whether to purchase Asset or Lease we first need to calculate some financial :

Reaming $ 30,000 will be financed from financial institute at 14% . Nothing specified about repayment hence continue with how it repaied in supplier loan. i.e. eually over 10 year Hence.... loan and interest schedule will be look like...

(assumed that loan prinicpal will remain equal over loan term)

Step : 6 Conclusion

• Net cash flow/ total net cost pf capital under purchase method is  79,901 where the same under Lease method it is 67,200.
• Therefore if cost be sole criterion then Asset should be leased as it leading benefit of $ 12,701.
• here time value of money i.e. present value is not considered as no discout factor rate is specified in the question. but even if the any discount rate would have been considered; the conclusion would remain the same to lease instead of purchase.