Interest payments would be made at the end of each year. Tax depreciation allowances would

be available to $M$ on the cost of the equipment at a rate of $100\%$ in the first year.

Alternative $2$

Take out a finance lease with a local finance house. The lease would have a four year term

and ownership of the equipment would pass to $M$ at the end of the lease period without

additional payment. Lease rentals would be $A$$$105$ million per annum, payable at the end of

each year.

Tax relief would be available on the accounting depreciation plus the interest implicit in

the lease rentals.

Alternative $3$

Purchase outright and undertake a rights issue at a discount of $15\%$ on today's share price.

Other relevant information

M pays corporate tax at a marginal rate of $20\%$ and tax is payable one year in arrears.

Required:

Assume you work in the Treasury Department of M;

Advise the Finance Director on the appropriateness of each of the THREE proposed

alternative methods of finance and recommend which, if any, should be chosen. In

your answer, include a calculation of whether the outright purchase funded by bank

borrowings or the finance lease is expected to be the cheaper source of debt funding.

Advice to FD

$[17$ marks$]$

Calculations

$[8$ marks$]$QUESTION $4[25$ MARKS$]$

$M$ is a manufacturer of high value electronic equipment based in Country A in Asia. It has

$285$ million shares in issue, which are, today, trading at A $$15\mathrm{.}65.$ M is currently all$-$ equity

financed. It is proposing to invest in equipment for a new production line that will be

introduced in $2017.$ The cost of the new equipment is A$$360$million and payment is due on

$01$ January $2017.$ The equipment is expected to have a useful life of four years and have

negligible value at the end of the four years.

The investment appraisal has shown a positive NPV using the company's weighted

average cost of capital.

$M$ is considering three alternative methods of financing the purchase of the equipment.

Alternative$1$

Purchase outright and fund with bank borrowings at an annual cost of $5\mathrm{.}0\%($after$-$tax$).$

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