LEASING

Q Classify and justify the lease classification:

Option 1: Company Leasing approached company ABC to lease equipment from it for five years. The
annual payment would be 20,000 dollars. The discount rate implied is 6%. Company ABC has an
incremental borrowing rate of 7%. After the 5 years, the asset will be transferred to the lessee, which
it will sell for scrap.

Option 2: Company L&R has also approached Company ABC to rent equipment from it. Under the term
of the rental agreement, Company ABC will rent the equipment from Company L&R for an annual fee
of 20,000 dollars. The equipment has an estimated useful life of 10 years. (F 1c, 2013)

Ans Option 1: Since the asset is transferred to the lessee at the end of lease term, this arrangement
will be classified as case of Financial Leasing.

Option 2: Since there is absence of any other information we will classify leasing arrangement as case
of Operating Leasing.

Q2 The following data is furnished by HLL

Investment cost = Rs 500 lakhs

Primary lease period = 5 years
Estimated residual value after primary period= nil
Pre tax required rate of return = 12%
The HLL determines the lease rentals under following structure
i. Stepped up (annual increase of 15%)
ii. Deferred (deferment period of 2 years)
iii. Equated

State whether the result is true/ false and give reasons thereof in each case.
i. Y1 = Rs 106.18 lakhs and Y5 = Rs 185.71 lakhs
ii. Y = Rs 200 lakhs
iii. Y = Rs 130 lakhs (Review que 2.7a Indirect)

Ans Equated annual lease rental (Y)

Y * PVFA (12,5) = 500 lakhs

Y = 500 lakhs/ PVFA (12,5)

= 500/3.605
= 138.69 lakhs

Stepped up lease rental

500 lakhs = Y* PVF(12,1) + 1.15Y* PVF(12,2) + 1.152Y* PVF(12,3) + 1.153Y* PVF(12,4) + 1.154Y* PVF(12,5)
500 = Y[ 0.893 + (1.15*0.797) + (1.152*0.712) + (1.153* 0.636) + (1.154* 0.567)]
500 = Y [ 0.893 + 0.917 + 0.941 + 0.967 + 0.991]

1
500 = 4.709Y
Y = 106.18 lakhs

Y2 = 122.10 lakhs, Y3 = 140.42 lakhs , Y4 = 161.48 lakhs and Y5 = 185.71 lakhs

Ballooned lease rental

500 lakhs = {80* PVFA(12,4)} + {Y*PVF(12,5)}

500 = {80* 3.037} + 0.567Y
500 = 242.96 + 0.567Y
Y = 500-242.96/ 0.567 = 453.33 lakhs

Deferred
500 lakhs = Y*PVF(12,3) + Y* PVF(12,4) + Y* PVF(12,5)
500 = Y { 0.712 + 0.636+ 0.567}
Y = 500/ 1.915 = Rs 261.096 lakhs

Q The following data is furnished by HLL

Investment cost = Rs 500 lakhs

Primary lease period = 5 years
Estimated residual value after primary period= nil
Pre tax required rate of return = 24%
The HLL seeks your help in determining the lease rentals under following structure
iv. Equated
v. Stepped up (annual increase of 15%)
vi. Ballooned ( annual rental of Rs 80 lakhs for 1-4 years ) (FMS 2b, 2015)

Ans Equated annual lease rental (Y)

Y * PVFA (24,5) = 500 lakhs

Y = 500 lakhs/ PVFA (24,5)

= 500/2.745
= 182.15 lakhs

Stepped up lease rental

500 lakhs = Y* PVF(24,1) + 1.15Y* PVF(24,2) + 1.152Y* PVF(24,3) + 1.153Y* PVF(24,4) + 1.154Y* PVF(24,5)
500 = Y[ 0.806 + (1.15*0.65) + (1.15 2*0.524) + (1.153* 0.423) + (1.154* 0.341)]
500 = Y [ 0.806 + 0.748 + 0.693 + 0.643 + 0.596]
500 = 3.4855Y
Y = 143.45lakhs

Y2 = 164.96 lakhs, Y3 = 189.71 lakhs , Y4 = 218.17 lakhs and Y5 = 250.89 lakhs

2
Ballooned lease rental

500 lakhs = {80* PVFA(24,4)} + {Y*PVF(24,5)}

500 = {80* 2.404} + 0.341Y
500 = 192.32 + 0.341Y
Y = 500-192.32/ 0.341 = 902.287 lakhs

Q The following data relates to leasing project.

Investment Outlay: 600 lakhs
Lease Term: 7 years
Residual Value: Nil
Rate of Return: 18%
Weighted Average Cost of Capital: 16%

Find lease rentals under following criterion:

• Equated
• Stepped (with annual increase of 10% )
• Ballooned ( Annual rental of 90 lakhs for 3 years )
• Deferred ( For 3 years ) (RQ 2)

Ans Equated annual lease rental (Y)

600 lakhs = Lease rentals * PVAF(@18%,7years)

Lease Rentals = 600/3.8115 = 157.418 lakhs

Stepped up lease rental

600= lease Rental *[(1/1.18)+(1.1/1.18^2)+(1.1^2/1.18^3)+(1.1^3/1.18^4)+(1.1^4/1.18^5)+
(1.1^5/1.18^6)+(1.1^6/1.18^7)]
600 = LR*[(1-(1.1/1.18)^7)/(1.18-1.1)]
LR= 600/4.8524 = 123.65 lakhs

YEAR Lease Rentals

1 123.65 lakhs
2 136.4 lakhs
3 150 lakhs
4 165 lakhs
5 181 lakhs
6 199 lakhs
7 219 lakhs

Ballooned lease rental

600 lakhs = 90*( 1/1.18+1/1.18^2+1/1.18^3) + LR*(1/1.18^4+1/1.18^5+1/1.18^6+1/1.18^7)
600 = 90*2.174 + LR*1.6372
LR = (600-195.684)/1.6372 = 247 lakhs

3
Deferred lease rental
600 lakhs = LR*(1/1.18^4+1/1.18^5+1/1.18^6+1/1.18^7)
600 = LR*1.6372
LR = 600/1.6372 = 366.53 lakhs

Q The Following Details relate to an investment proposal of Mahindra co. ltd.

Investment = 70 lakhs
Useful life = 5 years
Salvage value = 3lakhs
Rate of depreciation = 30%
The company has two alternatives to choose from :

1. Borrow and buy the equipment. The cost of capital is 26% , marginal rate of tax is 35% , cost
of debt is 19% p.a
2. Lease the equipment from supertech ltd. on a 5 year full payout lease @ 520/1000 payable
in arrears

Which alternative should it choose and why? Use NAL method (RQ 3)

Ans Investment outlay = 70 lakhs

-PV of lease rentals= 111.3112 lakhs

+PV of tax shield on lease rentals= 33.56 lakhs

-Tax shield on depreciation= 12.434 lakhs

-Tax shield on interest= 14.62 lakhs

-PV of tax shield on salvage value = 0.33 lakhs

NAL = -35.1352lakhs

Buying is preferable

WORKING NOTES:

1. PV of lease rentals= 0.520*70,00,000*PVAF(19%,5) = 11131120 or 111.3112L

2. PV of tax shield on LR = 0.520*70,00,000*PVAF(26%,5)*0.35 = 3356990 or33.56L
3. Tax shield on depreciation

YEAR COST DEPRECIATION@30% PVF@ 26% PV

1 70,00,000 21,00,000 0.794 16,67,400
2 49,00,000 14,70,000 0.630 9,26,100
3 34,30,000 10,29,000 0.500 5,14,500
4 24,01,000 7,20,300 0.397 2,85,959
5 16,80,700 5,04,210 0.315 1,58,826
35,52,785

Tax shield = 35,52,785*0.35 =12,43,475 or 12.43L

4. Tax shield on interest

Amount of loan = PV of lease rentals = 111.3112

4
Installment= 111.3112/PVAF(19%,5)= 36,40,000 or 36.4L

YEAR LOAN O/S INTEREST REPAID INSTALLMENT PVF@ 26% PV

@19%
1 1,11,31,120 21,14,913 15,25,087 36,40,000 0.794 16,79,241
2 96,06,033 18,25,146 18,14,854 36,40,000 0.630 11,49,842
3 77,91,179 14,80,324 21,59,676 36,40,000 0.500 7,40,162
4 56,31,503 10,69,985 25,70,014 36,40,000 0.397 4,24,784
5 30,61,488 5,81,683 30,58,317 36,40,000 0.315 1,83,230
4177259

Tax shield = 4177259*0.35 = 1462041 or 14.62L

5. PV of tax shield on salvage value = 3,00,000 * PVF(26%,5) * 0.35 = 33,075 = 0.33L

Q Welsh ltd is faced with a decision to purchase or acquire on lease a mini car. The cost of mini car is
Rs 154852. It has a life of 5 years. The car can be obtained on lease by paying in advance equal lease
rentals annually. The leasing company desires a return of 12% on gross value of assets. It can be
purchased by taking a loan at 18%pa which will be repaid in 5 equal annual installment, each
installment becoming due at the beginning of the year. The tax rate is 40% and the asset will be written
off over a period of 5 years on SLM. Advise Welsh Ltd about the method of acquiring the car. (F1b,
2013)

Ans Lease rentals = 154852/PVFA(12,5)

= 154852/ 3.605

= Rs 42955

PV of cash flows under leasing

Year end Lease payment Tax shield CO after tax PVF 11% PV

0 42955 - 42955 1 42955

1-4 42955 17182 25773 3.102 79948
5 - 17182 (17182) 0.593 (10189)
112714

PV of cash outflow under buying

Year end Loan Tax adv on Tax adv on Net CO PVF11% PV
installment interest dep
0 41965 - - 41965 1 41965
1 41965 8128 12388 21449 .901 19326
2 41965 6570 12388 23007 .812 18682
3 41965 4730 12388 24847 .731 18168
4 41965 2561 12388 27016 .659 17804
5 - - 12388 (12388) .593 (7346)
108572

Determination of interest and principal component

5
 Year end Loan Loan beg Interest Principal paid Loan OS end
installment
0 41965 154852 - 41965 112887
1 41965 112887 20320 21645 91242
2 41965 91242 16424 25541 65701
3 41965 65701 11826 30139 35562
4 41965 35562 6403 35562 -

PVF = 18(1-0.4) = 10.8 or 11% app

Dep = 154852/5 = 30970 Installment = 154852 = 154852 = 41965

PVFA(18,4) +1 3.690

Buying is better option

Q XYZ builders need to acquire the use of crane for construction purposes and considering buying or
leasing a crane. The crane costs Rs 1000000 and is subject to SLM of depreciation with zero salvage
value at the end of 5 years. In contrast the lease rent is Rs 220000 pa to be paid in advance each year
for 5 years. XYZ ltd can raise debt at 14% payable in equal annual installment, due at the beginning of
the year. The company is in 50% tax bracket. Should it lease or buy the crane? (F1d,
2014)

Ans

PV of cash flows under leasing

Year end Lease payment Tax shield CO after tax PVF 7% PV

0 220000 - 220000 1 220000

1-4 220000 110000 110000 3.387 372570
5 - 110000 (110000) 0.713 (78430)
514140

PV of cash outflow under buying

Year end Loan Tax adv on Tax adv on Net CO PVF7% PV
installment interest dep
0 255493 - - 255493 1 255493
1 255493 52115 100000 103378 .935 96658
2 255493 41527 100000 113966 .873 99492
3 255493 29456 100000 126037 .816 102846
4 255493 15635 100000 139858 .763 106712
5 - - 100000 (100000) .713 (71300)
589901

Determination of interest and principal component

Year end Loan Loan beg Interest Principal paid Loan OS end
installment

6
 0 255493 1000000 - 255493 744507
1 255493 744507 104230 151263 593244
2 255493 593244 83054 172439 420805
3 255493 420805 58912 196581 224224
4 255493 224224 31269 224224 -

Dep = 1000000/5 = 200000 Installment = 1000000 = 1000000 = 255493

PVFA(14,4) +1 3.914
Leasing is better option

Q Mehta and sons ltd is considering the acquisitions of large equipment to set up its factory in a
backward region for Rs.15,00,000. The equipment is expected to have an expected economic useful
life of 5 years. It can be obtained on lease by paying in advance lease rentals equal to Rs.4,16,100 per
annum. They can also obtain 100% finance from its regular bank channel. The annual rate of interest
is 18% and loan is repayable in five equal installments, each installment becoming due at the beginning
of the year. The equipment is subject to straight line method of depreciation for tax purposes.
Assuming no salvage value after 5 years and 30% tax rate, which of the financing alternative should it
select? (F 1, 2017)

Ans PV of cash outflows under LEASING

YEAR END LEASE TAX SHIELD @ CO after tax PVF@ 13% PV

PAYMENT 30%
0 416100 - 416100 1 416100
1-4 416100 124830 291270 2.974 866237
5 (124830) (124830) .542 (67658)
12,14,679

PV of cash outflows under BUYING

YEAR END LOAN TAX SHIELD TAX SHIELD NCO PVF@ 13% PV
INSTALLMENT ON INT ON DEP
0 406504 - - 406504 1 406504
1 406504 59049 90000 257455 .885 227848
2 406504 47726 90000 268778 .783 210453
3 406504 34366 90000 282138 .693 195523
4 406504 18626 90000 297878 .613 182559
5 - - (90000) (90000) .542 (48780)
1174152

Determination of interest and principal component

YEAR END LOAN INT @ 18% REPAID INSTALLMENT

0 1500000 - 406504 406504

1 1093496 196829 209674 406504
2 883821 159087 247416 406504
3 636404 114552 291951 406504
4 344452 62052 344452 406504

7
DEPRECIATION= 1500000/5= 300000

Installment= 1500000/(PVAF@18%,4)+1= 406504

Buying is preferable

Q Kapoor & Sons Ltd is considering the acquisition of capital intensive machinery to set up its factory
on the outskirts of Delhi for Rs. 50,00,000. The machinery is expected to have an economic useful life
of 5 years. It can be obtained on lease by paying in arrears an equal lease rentals of Rs 13,00,000 per
annum. Kapoor & Sons Ltd can also obtain 100% finance from its regular banking channel. The annual
rate of interest is 15% and loan is repayable in five equal installments, each installment becoming due
at the end of year. The equipment is subject to straight line method of depreciation for tax purposes.
Assuming no salvage value after the 5 year useful life and 40% tax rate, which of the financing
alternative i.e. leasing or buying should it select using the Present Value method? (F 2, 2018)

Ans PV of cash outflows under LEASING

Year End Lease Payment After PVAF@ 9% PV

Tax
1-5 13,00,000 (1-0.4) 3.890 30,34,200
780,000

PV of cash outflows under BUYING

Year End Loan Tax Shield Tax Shield Net CO PVF@ 9% PV

Installment On Int On Dep
1 14,91,647 3,00,000 4,00,000 7,91,647 .917 725941
2 14,91,647 2,55,501 4,00,000 8,36,146 .842 704035
3 14,91,647 2,04,327 4,00,000 8,87,320 .772 685011
4 14,91,647 1,45,478 4,00,000 9,46,169 .708 669888
5 14,91,647 77,988 4,00,000 10,13,659 .650 658878
34,43,753

Determination of interest and principal component

Year End Loan Int @ 18% Principal Installment

outstanding Repaid
1 50,00,000 7,50,000 7,41,647 14,91,647
2 42,58,353 6,38,753 8,52,894 14,91,647
3 34,05,459 5,10,819 9,80,828 14,91,647
4 24,24,630 3,63,695 11,27,952 14,91,647
5 12,96,677 1,94,970 10,96,677 14,91,647
DEPRECIATION= 5000000/5= 10,00,000

Installment= 5000000/(PVAF 15%,5)= 5000000/ 3.352 = 14,91,647

Leasing is preferable

Q Kara Ltd. Requires a machine costing Rs. 360500 having useful life of 5 years which can be leased or
acquired through a loan at 12% to be repaid in 5 equated annual installments payable in arrears. The

8
machine can be acquired on lease rentals of Rs. 1,20,000 for 5 years. Assuming straight line method
of depreciation and relevant tax rate as 30%, advise which option the company should be assuming

i) Lease Rentals are payable at the end of the year

ii) Lease Rentals are payable in advance (FS, 2017)

Ans

Loan Installment= Machine cost/ Annuity factor= 3,60,500/ PVAF (12,5) = 360500/3.605
= Rs. 100000

Year Installment Loan Outstanding Capital Interest Paid

1 100000 360500 56740 43260
2 100000 303760 63549 36451
3 100000 240211 71175 28825
4 100000 169036 79716 20284
5 100000 89320 89320 10680

Year Installment Tax Shield On Cashflow Pvf 8% Pv Of

Depreciation And Interest Cashflow
1 100000 0.3(43260+72100) 65392 .926 60552
2 100000 0.3(36451+72100) 67435 .857 57792
3 100000 0.3(28825+72100) 69722 .794 55360
4 100000 0.3(20284+72100) 72285 .735 53129
5 100000 0.3(10680+72100) 75166 .681 51188
PV of Cash flows 2,78,021

i) For lease rentals in arrears

Cash flow from leasing= (1-0.3)*(120000* PVAF(8,5)) = 3,35,412

ii) For lease rentals in advance:

YEAR LEASE RENTALS AFTER TAX LEASE PVF 8% PV

RENTALS
0 120000 120000 1 120000
1-4 120000 84000 3.312 278208
5 -36000 0.681 -24516
PV =373692

PVF = 12( 1-0.3) = 8.4% or 8% app

Buying is a better option in both cases

HIRE PURCHASE

9
Q Ms Shloka Mehta wants to gift an Audi car to her client on the wedding anniversary for which she
receives a hire purchase proposal from Mr Neeraj on the following terms: the cost of car shall be Rs.
15,00,000. The flat rate of interest to be charged shall be 20% p.a. The installments are to be paid
monthly for a year. You are required to calculate the monthly hire purchase installment and show the
split between principle and interest according to Sum of Year Digit Method. (F 3b, 2018)

Ans Interest = 1500000* 20/100 = 300000

Installment = 1500000+ 300000/12 = 150000

SOYD Method

Month Installment Finance charge Capital recovery

1. 150000 12/78*300000= 46152 103848
2. 150000 11/78*300000= 42306 107694
3. 150000 10/78*300000= 38460 111540
4. 150000 9/78*300000= 34614 115386
5. 150000 8/78*300000= 30768 119232
6. 150000 7/78*300000= 26922 123078
7. 150000 6/78*300000= 23076 126924
8. 150000 5/78*300000= 19230 130770
9. 150000 4/78*300000= 15384 134616
10. 150000 3/78*300000= 11538 138462
11. 150000 2/78*300000= 7692 142308
12. 150000 1/78*300000= 3846 146154

Q ABC Ltd offers hire purchase proposal to Mr Sharma for an equipment costing Rs 1500000 as follows:
flat interest @15%pa. The installments are to be paid on a monthly basis over a time of one year.
Calculate the hire purchase installment and show the split between finance charge and capital
recovery according to SOYD and SLM method. (FMS 2a, 2013)

Ans Interest = 1500000* 15/100 = 225000

Installment = 1500000+ 225000/12 = 143750

SOYD Method

Month Installment Finance charge Capital recovery

13. 143750 12/78*225000= 34615 109135
14. 143750 11/78*225000= 31730 112020
15. 143750 10/78*225000= 28846 114904
16. 143750 9/78*225000= 25962 117788
17. 143750 8/78*225000= 23076 120674
18. 143750 7/78*225000= 20192 123558
19. 143750 6/78*225000= 17308 126442
20. 143750 5/78*225000= 14423 129327
21. 143750 4/78*225000= 11538 132212
22. 143750 3/78*225000= 8654 135096
23. 143750 2/78*225000= 5769 137981

10
 24. 143750 1/78*225000= 2884 140866

SLM
Month Installment Finance charge Capital recovery
1-12 143750 18750 125000

Q MR. Nilesh proposes the following terms to Mrs. Anju for a Hire Purchase agreement. The cost of
machinery is Rs.150 Lakhs which can be purchased on annual installment over a period of 4 years. The
flat rate of interest to be charged is 13% and she makes a down payment of Rs.37.5 Lakhs. Calculate
the installment and show the split between finance charge and capital recovery as per ERI model.
(RQ 1)

Ans: Total amount of loan taken= (150-37.5) Lakhs=Rs. 112.5 Lakhs

Total charge for credit= 112.5*0.13*4= Rs. 58.5 Lakhs
Monthly installment= (112.5+58.5)/48 = Rs. 3.5625 Lakhs
Annual installment= 3.5625*12= Rs. 42.75 Lakhs

Trial and Error method

(In Lakhs)

YEAR Installment PVF 18% PVF 20% PV 18% PV 20%

1 42.75 0.847 0.833 36.21 35.61
2 42.75 0.718 0.694 30.69 29.67
3 42.75 0.609 0.579 26.03 24.62
4 42.75 0.516 0.482 22.06 20.61
114.99 110.51

Using interpolation we get= 18% + 114.99-112.5 * 2 % = 19.118%

114.99-110.51

( In Lakhs)

Year Outstanding Interest@19.118 Principal Paid Installment

Principal
1 112.5 21.48 21.26 42.75
2 91.24 17.42 25.33 42.75
3 65.91 12.59 30.16 42.75
4 35.75 7 35.75 42.75
58.5

11
Q Mr Rana wants to gift a Honda car to his client on 50 th birthday for which hire purchase proposal
from Mr Gupta on the following terms: the cost of the car shall be 9,00,000. The flat rate of interest
shall be 20%. The installments are paid annually for three years. Calculate the annual hire purchase
installment and split it into interest and capital according to

• Effective Rate of Interest Method

• Sum of the year Digit Method (F 2a, 2017)

Ans: Interest = 9,00,000*20*3/100 = 5,40,000

Amount = 9,00,000 + 5,40,000 = 14,40,000
Installment = 14,40,000/3 = 4,80,000

Effective Rate of Interest:

Year Installment Present Value Factors Present Value

1-3 4,80,000 25% 27% 28% 25% 27% 28%
1.952 1.896 1.868 9,36,960 9,10,080 8,96,640

Rate = 27% + [10080/(910080-896640)*1%]

Rate = 27.75%

Year Installment Principal ( at Effective Rate of Interest Sum of the Year Digit
beginning ) Principal Interest Paid Principal Interest
Repaid Repaid Paid
1 480000 900000 230250 249750 210000 270000
2 480000 669750 294144 185856 300000 180000
3 480000 375605 375605 104395 390000 90000

Q Mr X offers a hire purchase proposal to Mr Y on the following terms : the cost of equipment shall be
Rs 100000. The flat rate of interest to be charged shall be 15%pa. The installments are to be paid
annually in 3 years. You are required to calculate the installment and show the split between finance
charge and capital recovery according to ERI, SOYD and SLM method. (FMS 3b, 2014)

Ans Interest = 100000* 15/100* 3 = 45000

Installment = 100000+ 45000/3 = 48333

ERI Method

Year Installment PVF 20% PVF 22% PV 20% PV 22%

1 48333 .833 .820 40261 39633
2 48333 .694 .672 33543 32479
3 48333 .579 .551 27984 26631

12
 101788 98743
20% 22%
i I I =20% + [1788 * 2] %
101788 100000 98743 101788-98743

= 20% + 1.174% =21.174%

Year Installment Loan beg Int @ 21.174% Principal

/capital
recovery
1. 48333 100000 21174 27159
2. 48333 72841 15423 32910
3. 48333 39931 8402* 39931

SOYD Method
Year Installment Finance charge Capital recovery
1. 48333 3/6* 45000= 22500 25833
2. 48333 2/6* 45000= 15000 33333
3. 48333 1/6* 45000= 7500 40833

SLM
Year Installment Finance charge Capital recovery
1-3 48333 15000 33333

Q Mr Y offers a hire purchase proposal to Mr Z on the following terms: the cost of plant shall be
Rs3,00,000. The flat rate of interest to be charged shall be 15%p.a. The installments are to be paid
annually for three years. You are required to calculate the annual hire purchase installment and split
it between principle and interest using

(i) Effective rate of interest method

(ii) Sum of year digit method
(iii) Straight line method

Ans Interest = 300000* 15/100* 3 = 135000

Installment = 300000+ 135000/3 = 145000

ERI Method

Year Installment PVF 20% PVF 22% PV 20% PV 22%

1 145000 .833 .820 120785 118900
2 145000 .694 .672 100630 97440
3 145000 .579 .551 83955 79895
305370 296235
20% 22%
i I I =20% + [5370 * 2] %
305370 300000 296235 9135

13
 = 20% + 1.175% =21.175%

Year Installment Loan beg Int @ 21.175% Principal

/capital
recovery
1. 145000 300000 63525 81475
2. 145000 218525 46273 98727
3. 145000 119798 25202* 119798

SOYD Method
Year Installment Finance charge Capital recovery
1. 145000 3/6* 135000= 67500 77500
2. 145000 2/6* 135000= 45000 100000
3. 145000 1/6* 135000= 22500 122500

SLM
Year Installment Finance charge Capital recovery
1-3 145000 45000 100000

Q XYZ Ltd offers hire purchase proposal to Mr Gupta for a machinery costing Rs 50,00,000. The flat
rate of interest charged is 15% p.a. The installments are to be paid on a monthly basis over a period
of two years. Calculate the hire purchase installment and show the monthly split between finance
charge and capital recovery as per (i) Sum of Year Digit Method (ii) Straight Line Method

Ans Interest = 5000000* 15/100*2 = 1500000

Installment = 5000000+ 1500000/24 = 270833

SOYD Method

Month Installment Finance charge Capital recovery

1. 270833 24/300*1500000= 120000 150833
2. 270833 23/300*1500000= 115000 155833
3. 270833 22/300*1500000= 110000 160833
4. 270833 21/300*1500000= 105000 165833
5. 270833 20/300*1500000= 100000 170833
6. 270833 19/300*1500000= 95000 175833
7. 270833 18/300*1500000= 90000 180833
8. 270833 17/300*1500000= 85000 185833
9. 270833 16/300*1500000= 80000 190833
10. 270833 15/300*1500000= 75000 195833
11. 270833 14/300*1500000= 70000 200833
12. 270833 13/300*1500000= 65000 205833

14
 13. 270833 12/300*1500000= 60000 210833
14. 270833 11/300*1500000= 55000 215833
15. 270833 10/300*1500000= 50000 220833
16. 270833 9/300*1500000= 45000 225833
17. 270833 8/300*1500000= 40000 230833
18. 270833 7/300*1500000= 35000 235833
19. 270833 6/300*1500000= 30000 240833
20. 270833 5/300*1500000= 25000 245833
21. 270833 4/300*1500000= 20000 250833
22. 270833 3/300*1500000= 15000 255833
23. 270833 2/300*1500000= 10000 260833
24. 270833 1/300*1500000= 5000 265833

SLM
Month Installment Finance charge Capital recovery
1-24 270833 62500 208333

Q XYZ ltd is considering a proposal to acquire a machine costing Rs 1000000 involving a down payment
of 20% and balance payable in 10 annual equal installments at the end of each year, which includes
flat interest chargeable at 12%. Another option before it is to acquire the asset on lease rental of Rs
150000pa payable at the end of each year for 10 years. The following information is available:

I. Terminal value of Rs 200000 is realizable if the asset is purchased

II. The company provides depreciation on SLM
III. Tax rate is 40% and cost of capital is 10%

You are required to compute, analyse the cash flows and advise whether the company should buy or
lease the machine. (F 2a, 2012)

Ans Hire purchase : working notes

1. Down payment = 200000

2. Annual installment = 800000+ (800000* 12*10/100)
10
=Rs 176000

3. PV of HP installment
= 176000* PVFA(12,10)
= 176000* 5.65
= 994400

15
 4. PV of depreciation tax shield
=80000* 0.4* PVFA (10,10)
=32000* 6.145
= 196640

5. PV of SV
=200000* PVF (10,10)
=200000* 0.386
= 77200
Cost of hire purchase
Down payment 200000
Add: PV of HP installment 994400
Less: PV of dep tax shield 196640
Less: PV of SV 77200

920560
Leasing : w notes

1. PV of lease payment
=150000* PVFA(12,10)
=150000* 5.65
= 847500

2. PV of tax shield on lease payments

= 150000* 0.4* PVFA(10,10)
= 150000* 0.4* 6.145
=368700

3. PV of tax shield on charge for credit

Total interest = 960000
Interest per nanum = 960000/10 = 96000

PV = 96000* 0.4* PVFA(10,10)

= 96000*0.4*6.145
=235968

Cost of leasing
PV of lease payment 847500
Less: PV of tax shield on lease payments 368700
Add: PV of tax shield on charge for credit 235968

714768
Assumption – SLM is used for allocation of charge for credit
Leasing is better option

16
Q ABC ltd is considering a proposal to acquire a machine costing Rs 500000 involving a down payment
of 25% and balance payable in 4 annual equal installments at the end of each year, which includes flat
interest chargeable at 14%. Another option before it is to acquire the asset on lease rental of Rs
100000pa payable at the end of each year for 4 years. The following information is available:

I. Terminal value is nil if the asset is purchased

II. The company provides depreciation on SLM
III. SOYD method is used to allocate total charge for credit/ finance charge
IV. Tax rate is 50% and cost of capital is 18%

You are required to compute, analyse the cash flows and advise whether the company should buy or
lease the machine. (F 2c, 2016)

Ans Hire purchase : working notes

1. Down payment = 125000

2. Monthly installment = 375000+ (375000* 14*4/100)
4
=Rs 146250

3. PV of HP installment
= 146250* PVFA(14,4)
= 146250* 2.914
= 426173

4. PV of depreciation tax shield

=125000* 0.5* PVFA (18,4)
=125000*0.5* 2.69
= 168125

5 PV of SV = 0

Cost of hire purchase

Down payment 125000
Add: PV of HP installment 426173
Less: PV of dep tax shield 168125
Less: PV of SV -
383048

Leasing : w notes

1. PV of lease payment
=100000* PVFA(14,4)
=100000* 2.914
= 291400

17
 2. PV of tax shield on lease payments
= 100000* 0.5* PVFA(18,4)
= 100000* 0.5* 2.690
=134500

3. PV of tax shield on charge for credit

Year SOYD factor Annual charge PVF 18% PV
1 4/10 * 210000 84000 0.847 71148
2 3/10 * 210000 63000 0.718 45234
3 2/10 * 210000 42000 0.609 25578
4 1/10 * 210000 21000 0.516 10836
152796
Tax rate 0.5
76398

Cost of leasing
PV of lease payment 291400
Less: PV of tax shield on lease payments 134500
Add: PV of tax shield on charge for credit 76398

233298

Leasing is better option

FACTORING

Q Sanyo ltd sells goods on credit. Annual credit sales amount to 500 Lakhs. Credit terms are 2/10 net
30. On the current level of sales the bad debts are 2% the past experience is the 30% of the customers
avail cash discount, the remaining customers pay on an average of 60 days after the date of sale. The
book debts of the firm are presently being financed in the ratio of 2:1 by a mix of bank borrowings and
own funds which cost 22% and 30% pa respectively. As an alternative, it is contemplating use of
factoring with PNB factors. There would be saving of administrative overheads of 2.5 lakhs. According
to proposal PNB offers guaranteed payment within 30 days. PNB would advance 80% in case of
recourse and 85% in case of non recourse the balance would be retained as factor reserve. The
discount charge payable upfront is 22% for recourse and 21% for non recourse. Commission payable
is 2% and 4% respectively.

Decide between

a. In house and recourse factoring

b. In house and non recourse factoring (FS 1, 2017)

Ans Cost of in house management:

Bad debts = 10 (.02*500)

Cash discount = 3 (500*.3*.02)

Cost of funds = 15.42

18
Admin cost = 2.5

Total = 30.92

WORKING NOTES:

Average collection period = .3*10+.7*60=45 days

Cost of own funds= 500*45/360*1/3*.3=6.25

Cost of bank funds= 500*45/360*2/3*.22=9.17

Cost of recourse factoring:

Commission = 10 (500*.02)

Discount charge = 7.19

bad debt = 10

Cost of own funds = 2.7

Total = 29.89

WORKING NOTES:

Advance payment= (500-10)*.8 = 392

Average period = 30 days

Discount charge = 392*30/360*0.22 = 7.19

Cost of own funds = 0.3*(500-392)*30/360 = 2.7

Cost of non-recourse factoring:

Commission = 20 (500*.04)

Discount charge = 7.14

Cost of own funds = 2.3

Total = 29.44

WORKING NOTES:

Advance payment= (500-20)*.85 = 408

Average period = 30 days

Discount charge = 408*30/360*0.21 = 7.14

Cost of own funds = 0.3*(500-408)*30/360 = 2.3

19
I. Recourse factoring is preferable
II. Non Recourse factoring is preferable

Q Ramya Ltd sells goods on credit. Annual credit sales amount to Rs 900 lakhs. Credit terms are 2/10
net 30. On the current level of sales, the bad debts are 4%. The past experience is that 30% of
customers avail of cash discount, the remaining customers pay on an average of 60 days after the date
of sale. The book debts of the firm are presently being financed in the ratio 2:1 by a mix of bank
borrowings and owned funds which cost p.a. 21% and 24% respectively. As an alternative to in house
management of receivables, Ramya ltd is contemplating use of factoring deal with Andhra Bank. There
would be savings in administrative overheads amounting to 4 lakhs. According to the proposal, Andhra
Bank offers a guaranteed payment within 30 days. It would advance 70% in case of recourse factoring,
the balance would be retained as factor reserve. The discount charge payable is 22% per annum.
Commission payable upfront is 4%. Decide between in house and recourse factoring. (F1, 2018)

Ans Cost of in house management:

Bad debts = 36 (900*0.04)

Cash discount = 5.4 (900*0.02*0.3)

Cost of funds = 24.75

Admin cost = 4

Total = 70.15

WORKING NOTES:

Average collection period = .3*10+.7*60=45 days

Cost of own funds= 900*45/360*1/3*0.24=9

Cost of bank funds= 900*45/360*2/3*.21=15.75

Total cost= 15.75 + 9= 24.75

Cost of recourse factoring:

Commission = 36 (900*.04)

Discount charge = 11.088

bad debt = 36

Cost of own funds = 5.904

Total = 88.992

WORKING NOTES:

Advance payment= (900-36)*.7 = 604.8

20
Discount charge = 604.8*30/360*0.22 = 11.088

Cost of own funds = 0.24*(900-604.8)*30/360 = 5.904

Inhouse Management is preferable

HOUSING FINANCE

Q Calculate the EMI of MR A who has borrowed Rs 8 lakh for 5 years at an interest of 12% pa from the
bank if A) it is a home loan B) it is personal or consumer loan. (FMS 2013)

Ans Home loan = 800000/ PVFA (12,5)

= 800000/ 3.605

= Rs 221914

Consumer loan

Interest = 800000*5*12/100 = 480000

Installment = 800000 + 480000/ 5 = Rs 256000

Q Determine whether the home loan borrower should take loan on fixed rate or floating rate or
initially take loan in floating rate and switch from floating to fixed rate if the following information is
available:
Amount of loan Rs 15,00,000. Duration of loan is 20 years and loan to be paid on annual basis. The
terms of interest are fixed rate of interest: 9% pa or floating rate of interest 8% pa. After 9 years, the
floating rate is expected to rise to 10% pa and the corresponding fixed rate shall be 9% pa. Borrower
now decides to switch from floating to fixed rate. Determine whether or not it is a worthwhile decision
out of three alternatives given cost of switching over is 4% of the outstanding amount. (RQ1)

Ans Fixed rate

Annual installment = 1500000/PVFA (9%,20) = 1500000/9.129 = Rs 164312

Amount paid= 164312*20= Rs 32,86,220

21
Floating rate

Annual installment= 1500000/PVFA (8%,20) = 1500000/9.818= Rs 152780

Amount paid=

Year Installment Principal Interest @8% Principal paid

outstanding
1. 152780 15,00,000 1,20,000 32780
2. 152780 14,67,220 117378 35402
3. 152780 1431818 114545 38235
4. 152780 1393583 111487 41293
5. 152780 1352290 108183 44597
6. 152780 1307693 104615 48165
7. 152780 1259528 100762 52018
8. 152780 1207510 96600 56180
9. 152780 1151330 92106 60674
10. - 1090656 - -

New installment = 1090656/PVFA (10%,11)= 1090656/6.495= 167922

Total amount paid = (152780*9) + (167922*11)

= Rs 13,75,020 + 1847142
= Rs 32, 22,162
Floating to fixed

New installment = 1090656/ PVFA (9,11)= 1090656/ 6.805= 160212

Total amount paid= (152780*9)+ (160212*11)+ (4% of 1090656)

= Rs 31,81,638

Alternative III is the best

Q Mr Ishan wants to purchase 2 BHK flat for RS 30 lakh from gupta properties. He could pay only RS
10 lakh out of savings from fixed deposit and mutual funds so he decided to take a loan from AXIS
bank. The bank offers two schemes of loan of RS 20 lakh. Determine whether Ishan should take loan
on fixed rate or initially take loan at floating rate and switch from floating to fixed if the following is
available:

Amount of loan = 20 lakhs, Duration of loan = 10 years and Loan to be paid on annual basis. The terms
of the interest are fixed rate of interest: 10% pa or floating rate of interest 8% pa. After 4 years the
floating rate is expected to rise to 12 % pa and the corresponding fixed rate shall be 10 % pa. He now
decides to switch from floating to fixed rate. Determine whether or not it is a worthwhile decision
given cost of switching is 4% of outstanding loan. (F 2b, 2017)

Ans Fixed rate

Annual installment = 2000000/PVFA (10%,10) = 2000000/6.145 = Rs 325467.86

Amount paid= 325467.86 * 10= Rs 32,54,678

22
Floating to fixed rate

Annual installment= 2000000/PVFA (8%,10) = 2000000/6.710= Rs 298062

Year Installment Principal Interest @8% Principal paid

outstanding
1. 298062 20,00,000 1,60,000 1,38,062
2. 298062 18,61,938 1,48,955 1,49,107
3. 298062 17,12,831 1,37,026 1,61,036
4. 298062 15,51,795 1,24,143 1,73,918
5. - 13,77,876 - -

New installment = 1377945/PVFA (10%,6)= 1377876/4.355= 316405

Total amount paid= (4% of 1377876) + (298062* 4) + (316405*6)

= 55115+ 1192250 + 1898400

= 3145795

Floating to fixed is preferable.

INSURANCE

Q A 12 year boy purchases a 5 year pure endowment policy worth Rs 30000. Taking the interest rate
of 15%pa, determine what premium should be charged from him by the company when no
consideration is given for load factor. What will be your answer if the boy goes in for term policy

23
instead of pure endowment policy? (CSO Mortality tables: L17= 9818254, L12 = 9879752, d12=9089, d13=
10562, d14= 12227, d15= 13984, d16= 15636) (RQ1)

Ans Pure endowment

P = 30000 L17
(1.15)5 * L12

=30000* 9818254
(1.15)5 * 9879752

= 14910 * 0.994

= Rs 14820

Term policy

PL12 = 30000d12 + 30000d13 + 30000d14 + 30000d15 + 30000d16

1.15 1.152 1.153 1.154

P =30000[ 9089 + 10562+ 12227 + 13984+ 15636]

9879752 1.15 1.152 1.153 1.154

=30000[9089+ 9184.347+ 9245.368+ 9194.706+ 8939.933]

= Rs 138.62

Q A 40 years old purchases a 7 year pure endowment policy worth Rs 7000. Taking the interest rate
of 13%pa, determine what premium should be charged from him by the company when no
consideration is given for load factor. What will be your answer if the lady goes in for mix endowment
policy instead of pure endowment policy? (CSO Mortality tables: L40= 9548316, L47= 9335534, d40=
24157, d41= 26191, d42= 28304, d43= 30303, d44= 32471, d45= 34617, d46= 36739) (RQ2)

Ans Pure endowment

P = 7000 L47
(1.13)7 * L40

=7000* 9335534
(1.13)7 * 9548316

= Rs 2909.55

Mix endowment

PL40 = 7000d40 + 7000d41 + 7000d42 + 7000d43 + 7000d44 + 7000d45+ 7000d46+ 7000L47

1.13 1.132 1.133 1.134 1.135 1.136 1.137

24
 P =7000 [24157 + 26191+ 28304 + 30303+ 32471+ 34617+ 36739+ 9335534]
9548316 1.13 1.132 1.133 1.134 1.135 1.136 1.137

=7000 [24157+ 23177.876+ 22166.183+ 21001.499+ 19915.072+ 18788.721+ 17646.422+

9548316 3968168.09]

= 7000* 4115021.024/9548316

=Rs 3016.778

Q A 45 years woman purchases a 5 year term policy worth Rs. 60,000 from ICICI Prudential. Taking the
interest rate of 15% p.a. Determine what premium should be charged from her by ICICI Prudential
when no consideration is given for any load factor? (CSO Mortality Table ALB Females: L 45 = 9406890;
L50 = 9210440; d45 = 34617; d46 = 36739; d47 =39116; d48 =41648; d49 = 44330) (F 3a, 2018)

Ans Term policy

PL45 = 60000d45 + 60000d46 + 60000d47 + 60000d48 + 60000d49

1.15 1.152 1.153 1.154

P =60000[ 34617 + 36739 + 39116 + 41648+ 44330]

9406890 1.15 1.152 1.153 1.154

=60000[34617+ 31946.95+ 29577.31+ 27400+ 25360.41]

9406890

= 60000 * 148901.67
9406890

= Rs 949.74

25