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PROBLEMS FOR CLASS WORK

P–1: The Hypothetical Equipments Ltd (HEL) has recently leased assets worth Rs 2,500 lakh
from the Hypothetical Leasing Ltd ((HLL). The following facts are available.
1. Lease period, 9 years, of which the first 6 years constitute the lease term;
2. Annual lease rates: First 6 years, Rs 360/Rs 1,000; Next three years, Rs 15/Rs 1,000;
3. Incremental borrowing rates for HEL, 22 per cent.
(a) Assuming 14 years as the average economic life of the equipment, is the lease
finance lease or operating lease? (b) Assuming further (i) physical life of 14 years, (ii)
technological life 9 years, and (iii) product-market life of 11 years, how will you classify the
lease?

P-2 : A company is thinking of installing a computer. It is to decide whether the computer is to


be purchased outright (through 14 per cent borrowings), or to be acquired on lease rent basis.

The firm is in the 50 per cent tax bracket. The other data available is as follows:
Purchase of computer
Purchase price, Rs 20,00,000
Annual maintenance, Rs 50,000 per year paid in advance
Expected useful economic life, 6 years
Depreciation, Straight-line method
Salvage value, Rs 2,00,000
Leasing of computer
Lease charges (to be paid in advance), Rs 4,50,000
Maintenance expenses, to be borne by lessor
Payment of loan, 6 year-end equal instalments of Rs 5,14,271

P-3: XYZ Builders Ltd. need to acquire the use of crane for their construction business and are
considering buying or leasing a crane. The crane costs Rs.10,00,000 subject to SLM depreciation
with salvage value 0 at the end of 5 years. In contrast the lease rent is Rs.2,20,000 p.a. to be paid
in advance each year for 5 years.XYZ Builders ltd, can raise a debt at 14% payable in equal
annual instalments, each instalment due at the beginning of the year. Tax applicable in 35%.
Should it lease or buy the asset?

P-4: Magnum Leasing is in the business of providing automobiles on wet lease to corporate
clients. Magnum is considering a new model of Ford car for which an enquiry has come. The
cost of the vehicle is Rs.1.5 million. Its operating, maintenance costs, and insurance costs are
expected to be Rs.0.25 million in year 1; thereafter it will increase annually by 6 per cent. The
vehicle is expected to have a useful life of 6 years and it will fetch a net salvage value of Rs.0.6
million after that. The depreciation rate for tax purposes will be 40 per cent under the WDV
method. Magnum’s marginal tax rate is 35 per cent and its cost of capital is 10 per cent.

What is the minimum annual lease rental that Magnum should quote ? Ignore the cost of
negotiation and lease administration.

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