T-Man Ltd is a company that produces and sells lampshades. They have been operating for 5 years

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Question:

T-Man Ltd is a company that produces and sells lampshades. They have been operating for 5 years now and have seen some tremendous growth in their operations during this period. Due to the growth that they have experienced senior management, in a special resolution, decided that they wanted to invest in a new lampshade maker. They hired, on a temporary basis, a financial analyst to perform a capital budgeting cash flow analysis to determine the financial viability of the new machine. The new machine would give the company additional revenue of R30 000 per annum. The analysis yielded an NPV of -60 783.

Due to the negative NPV, the analyst concluded that the new machine should not be invested in.

Tshepo Voster, the financial director, was convinced that the machine was vital for expansion and that it would yield good returns. He investigated different financing possibilities. He found a local manufacturer that was willing to lease the machine to T-Man Ltd. The following information was given relating to the lease agreement (finance lease in terms of IAS 17):

Annual Lease payments R35 000 (in advance)

Lease period 5 years

Annual maintenance costs R5 000 (will be maintained at the end of each period)

Insurance costs Nil (covered by the lease agreement)

If the machine is purchased, the maintenance costs would amount to R15 000 per year and T-Man Ltd would have to pay additional insurance premiums of R400 per month. SARS will give a 25% wear and tear allowance on a straight line basis for the machine. The new machine will have a salvage value of R5 000 at the end of 5 years. The machine would cost of R200 000 to purchase. The company has a cost of capital of 14% and a before -tax cost of debt of 11.43%. The tax rate is 30%.

REQUIRED:

a) Calculate the net advantage of leasing the machine. (26 Marks)

b) Should T-Man Ltd reconsider obtaining the machine taking into account the financing option? Explain your answer. ………………………………………………………………………………………………………………………(2 Marks)

c) Briefly explain two disadvantages of sale and leaseback transactions. (2 Marks)