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FMS ASSIGNMENT

ON
LEASING

SUBMITTED BY:
NAME: ARNAB KUMAR DEB
SECTION: F1
ROLL NO.: 71
BATCH: PGDM 2016-2018
NEW DELHI INSTITUTE OF MANAGEMENT
Illustration 2.19 (Page no. 2.68)
Consider the following facts:
(A) About the Lessee (Hypothetical Industries LTD.)

Tax relevant of depreciation, 40 per cent


Useful life of an asset, 5 years
Estimated salvage value, NIL
Marginal cost of debt, 17 per cent (pre-tax)
Marginal cost of capital, 14 per cent
Marginal tax rate, 35 percent.

(B) About the Hypothetical Leasing ltd. (Lessor):


Minimum lease rental, Rs. 25/Rs1000/month i.e. (Rs. 25 ptpm), payable
in advance
Required minimum post-tax return on lease portfolio, 13 per cent
(a) What is break-even rental per Rs, 1000 for (1) the lessee and (2) the
lessor
(b) What is the (1) minimum lease rental of the lessee and (2) the maximum
lease rental of the lessor on an investment cost of Rs. 210 Lakh? The
equipment can be assumed to be imported without any sales tax
implication.
(c) Assuming the equipment is indigenously available, the CST on the
interstate sale is 4 percent for the lessee and 10 per cent for the lessor on
the basic price. Compute the monthly break even lease rental for the
lessee and the Lessor.

Solution:
1) Present value of lease rentals:
= 1200000 * PVIFAm (17, 5)
= 1200000 * 1.09 * 3.199
= Rs. 41.84 L
2) Present value of tax shield on lease rentals:
= 1200000 * PVIFA (14, 5) * 0.35
= 1200000 * 3.433 * 0.35
= Rs. 14.42 L
3) Present value of tax shield forgone on depreciation:
= [400 * PVIF (14, 1) + 240 * PVIF (14, 2) + 144 * PVIF (14, 3) +
86 * PVIF (14, 4) + 52 * PVIF (14, 5)] * 0.35 = Rs. 248.64
4) Present value of interest tax shield on displaced debt:
= [6.03 L * PVIF (14, 1) + 5.02 L * PVIF (14, 2) + 3.83 L * PVIF
(14, 3) + 2.44 L * PVIF (14, 4) + 0.84 L * PVIF (14, 5) = Rs. 4.75 L

(Displaced) Debt Repayment Schedule


YEAR AMOUNT CAPITAL INTEREST INSTALMENT
OUTSTANDING CONTENT CONTENT
1 41.84 L 5.97 L 6.03 L 12 L
2 35.87 L 6.98 L 5.02 L 12 L
3 28.89 L 8.17 L 3.83 L 12 L
4 20.72 L 9.56 L 2.44 L 12 L
5 11.16 L 11.16 L 0.84 L 12 L

Break Even Lease Rental for the Lessee


1 Investment Cost Rs. 1000
2 Present value of lease rentals Rs. 41.84 L
3 Present value of tax shield on lease rentals Rs. 14.42 L
4 Present value of tax shield foregone on Rs. 248.64
depreciation
5 Present value of the interest tax shield on Rs. 4.75 L
displaced debt

The break even rental is given by the equation: 1000 41.84L + 14.42L 248.64 4.75L = 0
L = Rs. 23.36
Where L represents rental per thousand per month (ptpm)

5) Present value of lease receipts:


= 1200000 * PVIFAm (13, 5)
= 1200000 * 1.069 * 3.517
= Rs. 45.12 L
6) Present value of the tax liability on lease receipts:
= [(12 L * 0.35) * PVIFA (13, 5)]
= Rs. 14.772 L
7) Present value of depreciation tax shields:
= [400 * PVIF (13, 1) + 240 * PVIF (13, 2) + 144 * PVIF (13, 3) +
86 * PVIF (13, 4) + 52 * PVIF (13, 5)] * 0.35 = Rs. 252.933

Break Even Lease Rental for the Lessor


1 Initial Investment Rs. 1000
2 Present value of lease receipts Rs. 45.12 L
3 Present value of tax liability on lease Rs. 14.772 L
receipts
4 Present value of depreciation tax shields Rs. 252.933

The break even rental for the lessor can be obtained by the equation:
45.12L 1000 14.772L 252.933 = 0
L = Rs. 24.62 (ptpm)

Minimum Lease Rental of the Lessor = 210 Lakh * 24.62 ptpm = Rs. 5.17 Lakh

Maximum Lease Rental of the Lessee = 210 Lakh * 23.36 ptpm = Rs. 4.91 Lakh

Thus, the break even rental required by the lessor (5.17 lakh) is more than the
maximum rental (4.91 lakh) the lessee is willing to pay. There is a positive
difference / spread and there is a scope for negotiating the lease rental (bargaining
area).

Monthly break even lease rental for the lessee: 218.4 lakh (210 lakh + 4% sales tax) *
0.02336 = Rs. 5.10 lakh

Monthly break even rental for the lessor: 221 lakh (210 lakh + 0.10 sales tax) *
0.02462 = Rs. 5.44 lakh

The spread is positive and there is a room for negotiation of a lease package
financially attractive to the lessor and the lessee.

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