Question $3(25$ Marks$)$

Stomers Limited $($Ltd$),$ an aluminum factory needs to acquire state of the art equipment costing R$750000$ in order to be

more competitive. The equipment can be purchased or leased. The after$-$tax cost of the debt is $7\%$ and the company is in

the $30\%$ tax bracket.

The terms of the lease and purchase plans are as follows:

Lease

The leasing agreement would require annual end$-$of$-$year payments of R$169000$ over the five years. The lessee will

exercise its option to purchase the equipment for R$60000$ at the termination of the lease.

Purchase

The cost could be financed with a five year, $15\%$ loan, requiring four equal instalments of R$220000$ and a final instalment

$($balloon$)$ payment of R$245194.$ The company will pay R$20000$ from year $3$ to year $5$ only, for a service contract that

covers all costs. The straight$-$line method of depreciation is used. The company plans to keep the machine beyond its

five year recovery period.

The interest payments for the respective five years are R$112500$ R$96375$ R$77831$ R$56506$ and R$31982.$

Round off final answers to the nearest whole number.

Required:

$3\mathrm{.}1.$ Present a brief argument in favour of leasing. $(5$ marks$)$

$3\mathrm{.}2.$ Determine the net present value of the cash outflows under each alternative $($round off to the nearest

rand$)$ and suggest the best alternative.