Case Study 2C (25 marks)

FurnCo Ltd is a manufacturer of office furniture. The company is required to invest in used tooling equipment at a cost of R7,5m. A finance company that specialises in the leasing of such equipment has offered either a 3-year lease requiring annual payments of R3 120 000 per year payable in-advance, or a loan which is repayable in a single repayment at the end of 3 years.

The leasing option includes servicing and maintenance with a value of R350 000 per year payable in arrears. The tax rate is 28%. Tax on the lease instalments is deductible one year after the payment and they take place at the beginning of each year. If the company takes the loan, the company will be required to pay for servicing and maintenance costs. The residual value is expected to be R3m in 3 years time. The cost of capital is 14% and the before tax cost of debt is 14,50%

The company is able to depreciate the cost of tooling equipment on a straight-line basis over 3 years. To acquire the office furniture at the end of the lease, the lessee is required to make a residual value of 25%.

Required:

Determine whether the company should borrow and purchase the machinery or lease the equipment. Assume the Loan amount is equal to its present value.

Case Study 2C ( 25 marks) FurnCo Ltd is a manufacturer of office furniture. The company is required to invest in used tooling equipment at a cost of R7,5m. A finance company that specialises in the leasing of such equipment has offered either a 3 -year lease requiring annual payments of R3 120000 per year payable in-advance, or a loan which is repayable in a single repayment at the end of 3 years. The leasing option includes servicing and maintenance with a value of R350000 per year payable in arrears. The tax rate is 28%. Tax on the lease instaiments is deductible one year after the payment and they take place at the beginning of each year. If the company takes the loan, the company will be required to pay for servicing and maintenance costs. The residual value is expected to be R3m in 3 years time. The cost of capital is 14% and the before tax cost of debt is 14,50% The company is able to depreciate the cost of tooling equipment on a straight-line basis over 3 years. To acquire the office furniture at the end of the lease, the lessee is required to make a residual value of 25%