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Agrani Ltd is in the business of manufacturing bearings. Some more product lines are being planned to be added to the existing system. The machinery required may be bought or maybe taken on lease. The cost of the machine is Rs 40,00,000 having a useful life of 5 years with a salvage value of Rs 8,00,000. The full purchase value of the machine can be financed by a 20% loan repayable in five equal installments falling due at the end of each year. Alternatively, the machine can be procured on a 5-year lease, year-end lease rentals being Rs 12,00,000 per annum. The company follows the written down value method of depreciation at the rate of 25%. The company's tax rate is 35 percent and the cost of capital is 16 percent.
Problem (i) Advise the company which option it should choose-lease or borrow.
Problem (ii) Assess the proposal from the lessor's point of view examining whether leasing the machine is financially viable at 14% cost of capital (Detailed working notes should be given. Calculations can be rounded off to Rs lakh).
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