Cold plc has decided to acquire equipment with a current market value of £700,000. A bank has offered a five-year loan at an interest rate of 13 per cent per year, provided it can reach agreement with Cold plc on ways to protect its investment. The equipment would be scrapped after five years and at that time would have negligible scrap value. Cold plc could also lease the equipment for £180,000 per year, payable at the start of each year. The lessor would be responsible for servicing the equipment whereas, if the equipment were bought, Cold plc would incur annual servicing costs of £25,000.
Cold plc is a profitable company that pays tax one year in arrears at an annual rate of 30 per cent and can claim annual capital allowances on a 25 per cent reducing balance basis.
(a) Discuss ways in which the bank could protect its loan of £700,000 to Cold plc for the equipment purchase.
Cold plc has decided to acquire equipment with a current market value of £700,000. A bank has offered a five-year loan at an interest rate of 13 per cent per year, provided it can reach agreement with Cold plc on ways to protect its investment. The equipment would be scrapped after five years and at that time would have negligible scrap value. Cold plc could also lease the equipment for £180,000 per year, payable at the start of each year. The lessor would be responsible for servicing the equipment whereas, if the equipment were bought, Cold plc would incur annual servicing costs of £25,000.
Cold plc is a profitable company that pays tax one year in arrears at an annual rate of 30 per cent and can claim annual capital allowances on a 25 per cent reducing balance basis.
(a) Discuss ways in which the bank could protect its loan of £700,000 to Cold plc for the equipment purchase.
(b) Calculate the present value of the tax benefits arising on capital allowances if Cold plc decides to purchase the new equipment.
(c) Calculate whether Cold plc should lease or buy the new equipment.