Reference no: EM133068495

Socks Ltd manufactures shoes and socks and wants to expand its product line. The management of the company has indicated that a new machine is required to manufacture a new line of brightly coloured socks. To purchase the machine, it has negotiated financing with a favorable before tax cost of 10% interest per annum, with equal annual instalments. Alternatively, the company can enter into a direct financial lease with the manufacturer of the machine, which means that the manufacturer will offer the machine with maintenance on it, for the useful life of the machine at a total cost of R90 000 per year, paid at the end of each year, for four years.

The machine costs R500 000 and it is expected that it will require maintenance of R40 000 per year, if bought. It is also expected that the machine can be sold for R40 000 at the end of its useful life of four years. The machine can be depreciated by way of the straight-line method over a period of four years.

A tax rate of 28% is applicable.

The company has a before- tax cost of debt of 10%.

Required:

Determine the net advantage of leasing and advise the company on the option they should take based on your findings.