11 Leasing versus purchase. MRF is a charitable organisation and exempt from all taxes. It is about to acquire some new capital equipment for a special project. The President of the charity has been advised that it might be advantageous to acquire the equipment with a finance lease. The cost to the charity of the equipment, if it were purchased outright, would be £22.5 million. However, the leasing company would be able to negotiate a 20 per cent discount on this price because of its longterm commercial relationship with the suppliers of the type of equipment being purchased. This discount would not be available to the charity if it purchased the equipment with a bank loan.

The leasing company is nearing its year end and is keen to obtain the tax advantages denied to MRF because of its charitable status. It has therefore offered what it considers to be very favourable terms. Payments by MRF would be £7.5 million per annum for 6 years, payable at the end of each year of the lease contract.

Writing down allowances are available to the leasing company at 25 per cent on a reducing balance basis. At the end of year 6, it is estimated that the second-hand value of the equipment would be £4 million. Insurance and maintenance would be the responsibility of the charity, whether it leases or purchases the equipment.

The cost of a bank loan to the charity would be 12 per cent. The opportunity cost of capital for the leasing company would be 14 per cent.

Assume no time lag in tax payments or refunds.

You should work to two decimal places throughout.

Required:

(a) Assume you are MRF’s treasurer. Evaluate the financial aspects of the lease and recommend to the President whether the charity should purchase with a bank loan or use a finance lease. You should state the reasons for your recommendation and any assumptions you make in arriving at your decision.

(b) Now assume that your are an account negotiator for the leasing company. You have been informed that MRF has decided to buy the equipment with a bank loan at