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Problem:

Sale-Sucre plc specialises in production and sale of pizzas. It is considering rising production and plans to invest in new kitchen oven costing Rs2, 400,000 payable instantaneously. The company can obtain the equipment in 2 ways:

• Outright purchase through a 4-year bank loan at a pre-tax interest cost of 8%. The terms of the loan agreement would necessitate an upfront transaction cost of Rs100, 000 and the loan would be repayable by equal annual instalments starting 1 year from now. 

• A financial lease with the annual rentals of Rs700, 000 over four year’s payable in arrears. Tax is levied at a rate of 15% and is payable in the year in which profit occurs. Depreciation is the tax-allowable expenditure and is granted only to the legal owner of the asset. Rentals payable by lessee under the lease arrangement are completely tax-deductible.

Required:

Assess which financing option the company must go for.

Accounting Basics, Accounting

  • Category:- Accounting Basics
  • Reference No.:- M99770

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