Question

1) Smith & Jones has been asked by Levi Manufacturing to quote on a 4-year lease for a machine which costs $375,000. The equipment can be depreciated for tax purposes over 4 years.

The equipment has a residual value expected to be $15,000 to be received at the end of the lease period which is taxed at the corporate tax rate.

Other details:                                                                                   

Company's Cost of Capital                                           10%                                                                       

Corporate Tax Rate                                                         30%                                       

All lease payments are received in advance, at the start of the year - (annuity due).

Required:

What is the ANNUAL LEASE PAYMENT that Smith and Jones should quote Levi Manufacturing?

2) Johnny Johnson commenced worked at the Jenson Laboratories on the 15^th June 1994. He is currently earning currently earning $76,500 per year.

Long service leave entitlement is calculated as 10 weeks leave after the first 10 years of service and 10 calendar days for every year worked in excess of 10 years (proportionate leave for partial year)

Required:

As at 31^st May 2017, calculate the amount of money owing to Johnny for his Long Service Leave entitlement.

Answer 1

Answer 1:

Given Initial Cost = - $375,000

The equipment can be depreciated for tax purposes over 4 years

Depreciation Per year = $375,000 /4 = $93,750

Salvage value = $15,000

As book value at the end of year 4 = $0, tax on salvage value = $15,000 * 30% =$4,500

Salvage value net of tax = $15,000 - $4,500 = $10,500

Cost of capital = Rate = 10%

First let us calculate NPV without considering annual lease receipts:

Now we need to calculate annual lease receipts (received in advance) so that present value of such annual lease payments = $278,675.89

Using PMT function of excel:

PMT(rate, nper, pv, fv, type)

PMT( 10%, 4, -278,675.89, 0, 1)

= $79,921.92

Hence Post tax annual lease receipt (in advance) = $79,921.92

We need to calculate pre-tax amount.

Hence, Annual lease receipt (in advance) = Post Tax annual lease receipt/ (1 - Tax rate)

= $79,921.92 / (1 - 30%)

= $114,174.17

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Just to confirm that the amount annual lease receipt is correct, NPV calculations are made taking annual lease receipts as income/inflow as below. Here we get NPV =$0 confirming that the annual lease receipt amount of$114,174.17 is correct.

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Answer 2:

Johnny Johnson commenced worked on the 15th June 1994

As on 14/06/2016, he completes 22 years.

Days from 15/06/2016 to 31/05/2017 = 351 days or 351/365 = 0.9616 years

As such total years of service as on 31/05/2017 = 22.9616 years

Long service leave entitlement:

First 10 years = 10 weeks

Balance 12.9616 years = 12.9616 * 10 = 129.616 days

Given, annual salary = $76,500

Per week salary = $76,500 /52

Per day salary = $76,500 /365

Amount of Long Service Leave entitlement = $76,500/ 52 * 10 + $76,500/ 365 *129.616

= $41,878