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Question 3 Rubinstein is a manufacturer in Swizland, a country which utilises the dollar currency. Lowenstein is a leasing firm in Swizland. Rubinstein intends to substitute an important machine in its firm and is initially considering the following 2 methods: Option 1 - buy the machine, financed by a 5-year debt. Option 2 - lease the machine from Rubinstein on a 5-year operating lease. The machine and its running costs The machine possesses a lifespan of around 11 years. However, Rubinstein is aware that there is fierce competition in the industry and the machine may be obsolete in 5 years' time. It would cost Rubinstein $6,000 to purchase the machine but Lowenstein has higher buying power and can purchase the machine for $5,000. Running costs of the machine are predicted to be $70 from Year 1 to 3 and $110 from year 4 to 5 , surfacing at the end of the year. Option 1 - acquisition paid by a 5-year term debt. $ rate of borrowing between commercial banks in Swizland are now 6.5% per annum. Rubinstein can borrow at this rate and include a margin of 1.8%. This rate is expected to remain unchanged for the 5 -year duration. It is predicted that the machine has a resale value of $3,000 at the end of 5 years. Option 2-5-year operating lease Based upon the operating lease, Lowenstein would be liable for the machine's running costs and will charge Rubinstein $950 per year for rental lease payments in advance for 5 years. Lowenstein knows that Rubinstein wants to lease rather than acquire the machine and wants to capitalise on this position by hiking up the operating lease rentals. On the other hand, it does not want to lose Rubinstein's business and seeks advice on the maximum lease rental that Rubinstein is willing to pay. Regulations related to taxes Swizland's regulations related to taxes provides tax depreciation allowances for the purchaser at 10% per year based upon a reducing balance technique. Depreciation is 35% per year based upon the same technique. The corporate tax rate is 40% and taxes are charged at the end of each year and be paid one year later. Option 3 - production manager's late proposal During the assessment process for option 1 and 2 , another lease was suggested as an option. This is referred to as Option 3. No figures are available currently to allow an assessment to be conducted for this option. The feature of this option 3 will be a 5-year lease with a renewal option at the end of the 5 -year term for an additional 5 -year term at insignificant rental cost. Rubinstein will be liable for the machine's running costs. Required (a) Utilise incremental cash flow analysis with consideration of time value of money to assess and compare the cost to Rubinstein of each options 1 and 2 . (18 marks) (b) Inform Lowenstein on the maximum rental lease payment that Rubinstein could tolerate under Option 2. (7 marks) [Total : 25 Marks]