Following is the case background, question and the souljtion. Can you give anoth
ID: 2796599 • Letter: F
Question
Following is the case background, question and the souljtion. Can you give another solution about this question? If you can, please give some explanations about the solution. Otherwise, you can give some explanations about the above solution. Thank you very much!SA SA INTERNATIONAL HOLDING LIMITED Sa Sa International Holding Limited (the "Company"), stock code 0178, is a listed co pany in the Hong Kong Stock Exchange Market. The Company is engaged in wholesi and retail of cosmetic products Assume the directors, Dr. Simon Kwok and Dr. Eleanor Law, have decided to expand its business and have liaised with the vendor, Ray Equipment, for a quotation. Ray Equipment has agreed to sell the equipment at a price of HKS3.8 million, at three-year MACRS depreciation. At the end of year four, the market value of the equipment is expected to be HK$250,000. Alternatively, the Company can lease the equipment from Ben Equipment Leasing. The lease agreement requires the lessee (the Company) t four annual payments of HKS990,000, due at the beginning of each year; and the deposit of HK$200,000 will only be returned to the Company at the end of the lease term. The Company may issue bonds with the 11.5 percent yield rate, and the tax rate is 17 percent. Questions 1. Would you suggest the Company to purchase or lease the equipment?
Explanation / Answer
The solution given was correct so, i am giving you explantion regarding the calculations and solution.
Purchase option:
The calculation of depreciation is as under
If purchased, as depreciation is a tax deductable expense, tax savings because of depreciation has to be taken into account for years 1 - 4. This is because depreciation expense will reduce the income, thus reducing tax expense, which is effectively a saving.
Salvage value at the end of 4th year is an income, which attracts tax. so, salvage value net of tax shoould be taken into account.
250,000 - (250,000* 17%) = 207,500
The resultant cash flows are then brought down to present day that is year 0, by multiplying with PV factors @ 11.5% p.a. The sum of all the discounted cash flows is resultant net prsent value of cash outflows
Lease option:
Given, annual lease payment is 990,000 and is to be paid at the beginnning of each year. So, Year 0 payment include annual lease rental and intial refundable deposit 200,000 + 990,000 = 1,190,000
Then as lease rental is a deductable expense, tax savings on tax rental should be considered.
The resultant cash flows are then brought down to present day that is year 0, by multiplying with PV factors @ 11.5% p.a. The sum of all the discounted cash flows is resultant net prsent value of cash outflows.
As NPV of cash outflows is less in lease option, SA SA International should opt for leasing option.
Hope I expained enough, if any further clarification is required, please feel free to comment.
Year Opening BV Rate % Depreciation Closing BV 1 3,800,000 33.33 1266540 2,533,460 2 2,533,460 44.44 1688720 844,740 3 844,740 14.81 562780 281,960 4 281,960 7.41 281,960 0