Problem 2

1. Distinguish between Operating and Financial Lease (4)

2. DAAP Plc plans to acquire a new machine on January 1. The cost of the machine is expected to be N2.5 million. When the machine is put into use the company plans to inject another N300.000 as working capital for the whole life of the machine. Once the machine starts operation, the company expects that it (the machine) will generate additional pre-tax operating net cash flows as follows

Year 1 $1.025 000

Year 2 $1.143 000

Year 3 $1.210 500

Year 4 $1.170 500

The company is considering whether to lease or buy the machine. If the machine is to be leased the company (lessee) would make an annual leas payment of N750.000 per annum for 4 years: with each payment at the beginning of the respective year If the machine is to be bought, the company would arrange ford term loan at a fixed rate of interest of 20% per annum The machine is not expected to have any salvage value. The company believe that the appropriate after-tax cost of capital for a machine in the same rise class as the one to be bought is 22 percent. Company tax is 30%, payable on year in arrears.

Capital allowances are available as follows:

50% initial allowance and 25% annual allowance on a reducing balance basis: These allowances have been calculated as follows:

Year	Initial allowance	Annual allowance
	50%	25%
1	1 250 000	312 500
2		239 375
3		175 781
Balance Allowance		390 836

Advise whether the machine should be bought or leased (15)