MSA Limited, a manufacturing company in South Africa, is intending to expand its output capacity by acquiring a new machine from South Korea in order to meet the expected increase in demand for energy saving globe. They are intending to utilise the machine in production for the next three years. The company has two options they can either lease or buy the machine. LEASE The company could lease the machine directly from the supplier for annual lease payments of R255 000, payable in arrears. The lease term is three years and the company will have the option to purchase the machinery on termination of the lease at a cost of R84 000. The financial manager intends to exercise the option. The lessee is responsible for the maintenance and insurance costs of the manufacturing equipment which is R2800 and R1100 per month respectively. BUY: The company could purchase the machine for R700 000 cash. The current total cost for insurance and maintenance combined is R75 000 per annum while the current running costs (water and electricity) for similar machines is R55 000 per annum. Maintenance and insurance is expected to increase from year 2 every year at the same rate of inflation which is expected to be 8% per annum. Due to improvements in the water supply and the use of renewable means of energy in the factory, running costs are expected to decrease at a rate of 5% per annum starting from year two. After the three-year period, MSA Limited will sell the machine for R150 000. Assume a tax rate of 30% applies and that the after-tax cost of debt is 11%
MSA Limited, a manufacturing company in South Africa, is intending to expand its output capacity by acquiring a new machine from South Korea in order to meet the expected increase in demand for energy saving globe. They are intending to utilise the machine in production for the next three years. The company has two options they can either lease or buy the machine. LEASE The company could lease the machine directly from the supplier for annual lease payments of R255 000, payable in arrears. The lease term is three years and the company will have the option to purchase the machinery on termination of the lease at a cost of R84 000. The financial manager intends to exercise the option. The lessee is responsible for the maintenance and insurance costs of the manufacturing equipment which is R2800 and R1100 per month respectively. BUY: The company could purchase the machine for R700 000 cash. The current total cost for insurance and maintenance combined is R75 000 per annum while the current running costs (water and electricity) for similar machines is R55 000 per annum. Maintenance and insurance is expected to increase from year 2 every year at the same rate of inflation which is expected to be 8% per annum. Due to improvements in the water supply and the use of renewable means of energy in the factory, running costs are expected to decrease at a rate of 5% per annum starting from year two. After the three-year period, MSA Limited will sell the machine for R150 000. Assume a tax rate of 30% applies and that the after-tax cost of debt is 11%
Financial Management: Theory & Practice
16th Edition
ISBN:9781337909730
Author:Brigham
Publisher:Brigham
Chapter19: Lease Financing
Section: Chapter Questions
Problem 6P: Big Sky Mining Company must install 1.5 million of new machinery in its Nevada mine. It can obtain a...
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1. Determine the after-tax cash flows and the
2. Which alternative would you recommend? Why?
Transcribed Image Text:MSA Limited, a manufacturing company in South Africa, is intending to expand its output capacity by acquiring a new
machine from South Korea in order to meet the expected increase in demand for energy saving globe. They are intending to
utilise the machine in production for the next three years. The company has two options they can either lease or buy the
machine.
LEASE
The company could lease the machine directly from the supplier for annual lease payments of R255 000, payable in
arrears. The lease term is three years and the company will have the option to purchase the machinery on termination of
the lease at a cost of R84 000. The financial manager intends to exercise the option. The lessee is responsible for the
maintenance and insurance costs of the manufacturing equipment which is R2800 and R1100 per month respectively.
BUY:
The company could purchase the machine for R700 000 cash. The current total cost for insurance and maintenance
combined is R75 000 per annum while the current running costs (water and electricity) for similar machines is R55 000 per
annum.
Maintenance and insurance is expected to increase from year 2 every year at the same rate of inflation which is expected to
be 8% per annum. Due to improvements in the water supply and the use of renewable means of energy in the factory,
running costs are expected to decrease at a rate of 5% per annum starting from year two. After the three-year period, MSA
Limited will sell the machine for R150 000.
Assume a tax rate of 30% applies and that the after-tax cost of debt is 11%
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