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In: Finance

QUESTION ONE Nyla Boilers is considering the acquisition of a new CNT machine for their operations....

QUESTION ONE
Nyla Boilers is considering the acquisition of a new CNT machine for their operations. The
machine may be purchased outright or leased.
The Purchase Option

Cash purchase R600 000
Annual software R10 000
Maintenance Costs
Year 1 and Year 2 R5000 per year
Year 3 R 9000
Year 4 R20 000

The machine will be sold after 4 year for 15% of its cash purchase price.

The Leasing Option
An initial deposit of R80 000 is required and the lease will run for 4 years. Annual payments of
R120 000 need to be made at the end of each of the four years. On expiry of the 4th year the
deposit will be refunded. No other costs will be borne by Nyla Boilers.
The rate of return is 7%
Tax rate: 30%
Required:
1.1 Determine the present value of cash flows associated with each alternative. (22)
1.2 Which option will you recommend to Nyla Boilers. (3)

Solutions

Expert Solution

(1.1) Let's evaluate both options:

Assumption:

Purchase Option: Book value of machine after 4 years is more than the resale value (15%), so no tax liability arises.

Lease Option: Machine is not bought by Lessee after lease period, so tax liability doesn't rise in this case as well.

(1.) Purchase Option:

CF0 CF1 CF2 CF3 CF4
Initial Cost -600000 - - - -
Annual Software - -10000 -10000 -10000 -10000
Maintenance -5000 -5000 -9000 -20000
Resale Value (15% of Cash Value) - - - +90000
Total Cash Flow -600000 -15000 -15000 -19000 +60000
PV of Cash Flow (Discount rate of 7%) -600000 -14019 -13102 -15510 53309
PV of total cost -589322

(2.) Lease Option:

CF0 CF1 CF2 CF3 CF4
Deposit -80000 - - - -
Annual Lease Payment - -120000 -120000 -120000 -120000
Refund of Deposit - - - - +80000
Total Cash Flow -80000 -120000 -120000 -120000 -40000
PV of CF -80000 -112150 -104813 -97956 -35540
PV of total cost -430457

(1.2)

Since lease option costs less as compared to Purchase option, I'll recommend for the lease option.

jeff jeffy answered 1 year ago
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