Leasing valuation
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This document provides details about Mitto manufacturing company which leases out machines to other companies. It asks to evaluate the leasing option for Mitto and calculate the break even and minimum lease rentals needed to earn a target NPV of Rs. 10,000. The evaluation shows the leasing provides Mitto with a positive NPV of Rs. 21,669. The break even lease rental is calculated to be Rs. 56,265. And the minimum rental to earn the target NPV of Rs. 10,000 is Rs. 61,185.
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Leasing valuation
- 1. Q . Following are the details available from the books of Mitto manufacturing company. The company is in the business of leasing out machines to corporate houses which manufacture computer chips 1 .Cost of machinery to be leased out Rs 150000 2 .Estimated useful life 5 years 3 .Estimated salvage value Rs 10000 4 .Estimated lease rental Rs 45000 PA 5 .The company follows WDV method of depreciation at 25% Assuming tax rate of 35%, You are required to (a) Evaluate the leasing option to the company (b) Calculate the break even lease rental and minimum lease rental to be charge by the company if the expected NPV to be earned is Rs10000
- 2. The company’s overall Cost of capital is 18% The PVF @ 18% are Year 1 2 3 4 5 PVF 0.847 0.718 0.609 0.516 0.437
- 3. Solution: (a) Annual depreciation charge: Year Book value Depreciation Balance at the end 1 150000 37500 112500 2 112500 28125 84375 3 84375 21094 63281 4 63281 15820 47460 5 47460 11865 35595
- 4. (b) Capital loss on Salvage value: 35595 - 10000 = 25595 (c) Tax shield (savings) on capital loss: 25595 *.35 = 8958
- 5. (d) Evaluation table Particulars 0 1 2 3 4 5 Cost of machine (1) (150000) ------ ------- ------ ------ ------ Lease rent (2) ----- 45000 45000 45000 45000 45000 Depreciation (3) ----- (37500) (28125) (21094) (15820) (11865) EBT (4) ----- 7500 16875 23906 29180 33135 Tax @ 35%(5) ----- (2625) (5906) (8367) (10213) (11597) EAT (6) ----- 4875 10969 15539 18967 21538 Estimated Salvage ----- ----- ----- ----- ----- 10000 value (7) Tax savings (8) ----- ----- ----- ----- ----- 8958 Net cash flow (1+3+6+7+8) (9) (15000) 45375 39094 36663 34787 52361 PVF (10) 1.00 0.847 0.718 0.609 0.516 0.437 PV of Net cash flow (9)*(10) (15000) 35892 28069 22309 17950 24111 Net present value (21669)
- 6. Calculation of B/E lease rental: ( NPV of leasing benefits + target NPV expected to be earned ) PV of annuity at COC] 1 – tax rate
- 7. NPV of leasing benefits : = 150000 – [(10000*0.437)+(37500*.35*0.847)+(28125*.35*0.71 8)+(21094*.35*0.609)+(15820*.35*0.516)+(11865*.3 5*0.437)+(8958*0.437) = 150000 – [4370+11117+7068+4496+2857+1815+3915] = 150000 – 35638 =114362
- 8. Break even rental: 114362 3.127 = 1 – 0.35 36572 = 0.65 = 56265
- 9. Calculation of desired lease rental to be charged : Required NPV of leasing benefits + target NPV to be earned PV of annuity to over all COC = 1 – tax rate 114362 + 10000 3.127 = 0.65 = 61185