Strategic Financial Management
UNIT 3
Question 1. ABC Ltd wants to lease out an asset costing Rs.3,60,000 for a five-year period it
has a fixed rental of Rs.1,05,000 per annum payable annually starting from the end of first year.
Suppose rate of interest is 14% per annum compounded annually on which money can be
invested. Find out which agreement favourable to the company.
Solution:
Present Value of the Given annuity of 1,05,000 for a 5 year at the interest rate of `14% p.a
compounded annually V=A*P (n , i)
(PVIFA 5 years 14%=3.43308)
V=1,05,000 *3.43308= Rs 3,60,473.40
Which is greater than initial cost of asset and subsequently leasing is favourable to the lessor
Question 2. A person wants to lease out a machine costing 5,00,000 for a 10 year period. It has
fixed a rental of 51, 272 per annum payable annually starting from the end of first year. Suppose
rate of interest is 10% per annum compounded annually on which money can be invested. To
whom this agreement is favourable?
(a) Favour of lessee
(b) Favour of lessor
(c) Not for both
(d) Can't be determined
Solution:
PV of Lease rentals= 6.144*51272= 3,15,066 Rs.
Which is less than initial cost of asset and subsequently leasing is favourable to the lessee.
Question 3. CBE ltd wants to lease out an asset worth 100 lakhs for a 4-years period. The
assets are to be written off at 25% under the Companies Act qualifies for 30% depreciation
under the income tax Act, At the end of the lease period it can be sold at whether is its tax
WDV. Cost of capital after tax is 10% and the tax is 25%. Determine whether a lease rental of
₹30 lakhs per annum payable in arrears advantageous to CBE ltd. Salvage Value = ₹ 24.01
lakhs.
Solution:
Stage 1- Initial Cash flows
Cost of assets = Rs100 Lakhs
Stage 2- In between Cash flows
Lease Depreciation Lease-
Rental (Rs Value of Machine WDV method PBT=Cost- % of Tax Tax=Cas
Year Lakhs) at the end of yr Cost*Depr % depreciation (PBT*.25) h Flows
1 30 100-30=70 30 30-30=0 0 30.00
2 30 70-21=49 21 30-21=9 2.25 27.75
3 30 49-14.7=34.3 14.7 30-14.7=15.4 3.85 26.25
4 30 34.3-10.29=24.0 10.29 30-10.29=19.7 4.9275 25.07
Stage 3- Terminal cash flows
Scrap value=24.01 lakhs
Stage 4- Analysis
Discount
Year Cash Flow Factor 10% PV CF
0 -100 1 -100
1 30.00 0.909 27.27
2 27.75 0.826 22.92
3 26.25 0.751 19.64
4 25.07 0.683 17.12
4-Scrap 24.01 0.683 16.40
NPV 3.3535
Interpretation: Since NPV is Positive Lease is positive
Question 4. Company X ltd wants to give out an asset costing ₹7,20,000 on lease for five years period.
1,80,000 per annum payable annually in advance. Is the arrangement favourable? The company enjoys
a nil tax status. Its costs of capital is 10%. Is it agreement favourable to it?
Solution:
Costing Rs.7,20,000 for a five-year period
Fixed Rental=1,80,000
PV of rental paid in 5 years= 1,80,000*3.791=6,82,380
NPV= (37,620)
Since NPV is negative Leasing is favourable to Lessee.
Question 5. Company XYZ ltd buys an asset for ₹4,24,000 at the end of its useful life of 5 years it will
have no realizable value. The assets are leased out to PQR ltd. First payment is made on the date the
contract is signed. What is the implied rate it the lease rentals are fixed at ₹ 1,00,000 payable annually
in advance?
Solution:
Stage 1: Cost of Assets = 4,24,000
Advance= 1,00,000
Remaining=3,24,000
Hence Investment=3,24,000 Rs
PV of Lease payments =1,00,000*PVIFA (9%, 4 years) =1,00,000*3.24=3,24,000
Hence implied rate=9%
Question 6. XYZ ltd wants to lease an asset costing ₹4,20,000. The useful life of the asset is 4 years,
Rentals are payable annually in arrears. The estimated net realizable value is 20,000. Lease rentals are
fixed at ₹ 1,28,000. XYZ is subject to Corporate tax of 40%, Asset depreciation at 25% SLM after
taking into account the RV and that this is allowed under tax. Compute the implied post tax of return.
Stage 1: Cost of Assets=Rs 4,20,000
Cash outflows
Stage 2: In between Cashflows
Year Rental Depreciation PBT Tax PAT CFAT
0
1 to 4 1,28,000 1,05,000 23,000 9,200 13,800 1,18,800
Depreciation using SLM= 4,20,000*.25=1,05,000 Rs
Stage 3: Net Realizable value= 20,000
Stage 4: Analysis
Annuity= 420000/118800
3.535354
After looking at PVIFA table 5%, 4 years
