Question

ABC Ltd., is in the business of manufacturing of toys. The firm is planning to develop a new toy. The firm either can buy the required machinery or get it on lease. The machine can be purchased for Rs. 60,00,000. It is expected to have a useful life of 5 years with a salvage value of Rs. 4,00,000 after the expiry of 5 years and depreciation on straight line basis. Alternatively, the machine can be taken on year-end lease rentals of Rs. 18,00,000 for 5 years. Advice the company on the option it should choose. following are the further derails
1. Tax rate is 35 per cent and cost of capital is 20 per cent.
2. Lease rentals paid at the end of the year.
3. Maintenance expenses Rs. 1,20,000 per year to be borne by the lessee.

Please provide excel along with formula

Answer 1

A) If Machine is bought

Particulars	0	1	2	3	4	5	NPV
Cost of Machine	-6000000
Depreciation		-1200000	-1200000	-1200000	-1200000	-1200000
Tax Savings @ 35%		420000	420000	420000	420000	420000
Salvage value 400000-35%						260000
Cash flow	-6000000	420000	420000	420000	420000	680000
PVIF @ 20%	1	0.8333	0.6944	0.5787	0.4823	0.4019
PV	-6000000	350000	291667	243056	202546	273277	-4639455

If machine is lease

Particulars	0	1	2	3	4	5	NPV
Lease payments		-1800000	-1800000	-1800000	-1800000	-1800000
Tax Savings @35%		630000	630000	630000	630000	630000
Cash flow after tax		-1170000	-1170000	-1170000	-1170000	-1170000
PVIF @ 20%		0.833333	0.6944444	0.5787037	0.4822531	0.4018776
PV		-975000	-812500	-677083	-564236	-470197	-3499016

Since in leasing option there is less cash outflow, one should lease the machine.
Maintenance expenses is common for both option and hence it is ignored