Joseph’s Engineering Ltd need to acquire new equipment and it can either take a
ID: 2329737 • Letter: J
Question
Joseph’s Engineering Ltd need to acquire new equipment and it can either take a loan or have a lease option. The loan funds of $100 000 at 8.2% p.a. after tax, compounded semi-annually for 2 years. The company has three directors in the business and they pay individual income tax at an average rate of 35%. Inland Revenue Department (Tax office) allows depreciation at the rate of 50% p.a. on this equipment. Advise the company which is the better deal, the loan or a 2 year lease with four equal payments of $26,674 starting with the first payment at the signing of the contract. Assume that corporate tax rate is 28% for simplicity’s sake the tax benefits from each lease payment and the tax benefits forgone for depreciation are received without time lag in each half-year period. Required: a. Which method of financing would you recommend? Why? (Hint: Show analysis of cash flow) b. List potential benefits associated with leasing?
Explanation / Answer
Solution:-
=2,100 * 35%
= $735
= (2100 + 50,000) * 35%
= $18,235
= 2100 * 35%
= $735
=( 2100 + 50,000) * 35%
= $18,235
= 2100 - 735
= $1,365
= 18,235 - 2,100
= $16,135
= 2,100 - 735
= $1,365
= 18,235 - 2,100
= $16,135
=( 16,135 + 16,135)- (1,365 + 1,365)
= 32270 - 2730
= $29,540
= 26,674 + 26,674 + 26,674 + 26,674
= $1,06,696
(b).Equipment leasing is most beneficial to companies when:-
option 1 loan intrest rate 8.2% half yearly 0 6months 12months 18 months 24months loan $1,00,000 (1,00,000) interest $2,100 $2,100 $2,100 $2,100 Depreciation ($50,000) ($50,000) Tax benefits (35%)=2,100 * 35%
= $735
= (2100 + 50,000) * 35%
= $18,235
= 2100 * 35%
= $735
=( 2100 + 50,000) * 35%
= $18,235
Net cash flow= 2100 - 735
= $1,365
= 18,235 - 2,100
= $16,135
= 2,100 - 735
= $1,365
= 18,235 - 2,100
= $16,135
Total cash flow=( 16,135 + 16,135)- (1,365 + 1,365)
= 32270 - 2730
= $29,540
Option 2 Lease 0 0months 6months 12months 18months Lease amount $26,674 $26,674 $26,674 $26,674 Depreciation $0 $0 $0 $0 Tax benefits (35%) $0 $0 $0 $0 Net cash flow $26,674 $26,674 $26,674 $26,674 Total cash flow= 26,674 + 26,674 + 26,674 + 26,674
= $1,06,696
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