QUESTION $2(46$ marks$)$

Livra $($Pty$)$ Ltd $($Livra$)$ is a courier and transport entity that provides services

nationwide across South Africa. Livra$$s business has grown significantly over the last

few financial periods, and consequently, a need for an additional delivery truck to

Livra$$s current delivery truck fleet exists.

Livra prefers to incorporate the delivery truck brand and model, Kiha Z$118$ in the

entity$$s delivery truck fleet, as the entity has found these delivery trucks to be reliable,

load capacity sufficient and economical on fuel usage. A Kiha Z$118$ delivery truck

$($hereafter referred to as $$Kiha Z$118)$ has a purchase price of R$654500$ in the free

market.

After evaluating Livra$$s current capital structure and comparing it to the optimal capital

structure for the entity, Livra$$s directors decided to finance the acquisition of a Kiha

Z$118$ with a debt $$ either by means of a loan or lease.

Debt financing option $1$: Loan

Financer Bank is willing to extend the necessary funds to Livra through a four $(4)$ year

loan with an interest rate of $11\mathrm{.}7\%$ quarterly compounding attached to the loan. Equal,

annual repayment instalments will be required, payable in advance.

Should Livra wish to borrow the funds and acquire right of ownership of Kiha Z$118,$

Livra will be required to pay for service and maintenance themselves.

According to Livra$$s property, plant and equipment policy, vehicles and thus Kiha

Z$118,$ are to be depreciated over three $(3)$ years on the straight$-$line basis. Kiha Z$118$

vehicles qualify under section $11($e$)$ of the South Africa Income Tax for a wear$-$andtear allowance. Section $11($e$)$ requires the diminishing balance method to be applied,

but for ease$$s sake $($and exclusively for the purpose of this scenario$),$ the straight$-$line

method may be used. Further, section $11($e$)$ allows for a $4-$year wear$-$and$-$tear

allowance period.

$7$ HFMN$230-1\_$Jan$-$Jun$2024\_$SA$1\_$V$3\_$ES$\_05022024$

Debt financing option $2$: Lease

Omnis Ltd $($Omnis$)$ is an entity that extends leases for various assets to outside

parties.

Kiha Z$118$ can be leased from Omnis over a four $(4)$ year period for R$138500$ payable

semi$-$annually in arrears.

According to the lease agreement, the service and maintenance cost of Kiha Z$118$ is

included in the lease payments.

In order to purchase the Kiha Z$118$ when the lease comes to an end, a payment of

R$37000$ can be made to Omnis. It is Livra$$s intention to proceed with such an

acquisition, should Livra opt for lease financing.

Additional information:

$$ From market research and past experience, it is known that Kiha Z$118$ trucks

require annual service and maintenance for which amounts to R$63000$ per

annual service.

$$ The South African Income Tax rate applicable to companies is $27\%.$

$$ Livra is required to complete and submit tax assessments annually at the end

of each year to the South African Revenue Services $($SARS$).$

$$ Livra$$s target weighted average cost of capital $($WACC$)$ is $12\mathrm{.}9\%.$ Livra

ensures that all financing decisions made are made in line with this.

$$ Livra$$s cost of debt before tax is $12\mathrm{.}3\%.$

$$ Once the four $(4)$ year anniversary has been reached, Livra will dispose of this

Kiha Z$118$ for a residual value of R$49300.$

$8$ HFMN$230-1\_$Jan$-$Jun$2024\_$SA$1\_$V$3\_$ES$\_05022024$

REQUIRED:

$2\mathrm{.}2.$ Advice Livra $($Pty$)$ Ltd whether the entity should finance the Kiha Z$118$

acquisition by entering into the lease or the loan agreement. Support your

advice by determining the Net Present Cost $($NPC$)$ of both options separately.

$(34$ marks$)$