Please write a report around 500 words. BenCEO of Ben Equipment Leasingoffers a
ID: 2796700 • Letter: P
Question
Please write a report around 500 words. BenCEO of Ben Equipment Leasingoffers a purchase option to the Company to purchase the equipment at the fair market value at the end of the lease term.How would the inclusion of the purchase option affect the value of the lease SA SA INTERNATIONAL HOLDING LIMITED Sa Sa International Holding Limited (the "Company"), stock code 0178, is a listed com- pany in the Hong Kong Stock Exchange Market. The Company is engaged in wholesale 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 HK$3.8 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) to make four annual payments of HK$990,000, 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. Company may issue bonds with the 11.5 percent yield rate, and the tax rate is 17 peremExplanation / Answer
In the given case, the inclusion of a right to purchase the equipment at fair market value at the end of the lease term will have no effect on the overall value of the lease. It is so because even if there is no such right, the company is free to purchase a similar type of equipment from the market at a similar price. As the fair value (at the end of the lease period) of the asset cannot be estimated at the inception of the lease, the lessee cannot be provided with the exact price at which the asset (equipment) can be purchased after the expiry of the lease term. Therefore, the lessee is not getting any additional advantage/value by getting an option/right to the buy the asset at fair value. However, If the asset is available (under lease) for purchase at a price lower than the fair market value at the end of the lease, the lessee would have obtained some additional advantage/value by exercising the option. This may cause an increase in the value of the lease. The lessee may agree to a situation where the asset will be available (at the end of the lease) at a fixed price or there is a bargain purchase option provided in the lease.