Elite Academic Institute 068 053 513 262 1185
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Educating the world for a better change
,Elite Academic Institute 068 053 513 262 1185
WARNING: PLEASE NOTE THAT PLAGIARISM IS A SERIOUS ACADEMIC
OFFENSE, therefore, the documents provided here including past assignments, tests and
notes are intended SOLELY for educational purposes and as a guide to help students
understand academic concepts and improve their writing skills. These materials should
not be submitted as final work, as doing so may constitute academic dishonesty. Students
are encouraged to use them as reference points, develop their own understanding and
produce original work that reflects their knowledge and critical thinking. Students are also
encouraged to regenerate their own (personalized) solutions paying particular attention
to module contents as prescribed by module facilitators, lecturers and supervisors. If this
document is plagiarized by the users and fails, ELITE ACADEMIC INSTITUTE should not
be rendered accountable since the contents in this document only give learners a kick-
start on what is expected of them from their areas of specialty.
CAUTION: STUDENTS ARE NOT MANDATED TO USE ALL THE INFORMATION IN
THIS DOCUMENT IN WRITING THEIR ASSIGNMENTS
Educating the world for a better change
,Elite Academic Institute 068 053 513 262 1185
QUESTION 1
1.1 Determine the after-tax cash flows and the net present value of the cash 1.1 1.2
outflows under each alternative. (23 marks)
This analysis compares the Lease and Purchase alternatives using the Net Present Value
(NPV) method, which identifies the option with the lowest present value of cash outflows.
The discount rate is the 7% after-tax cost of debt, and the corporate tax rate is 30%.
Alternative 1: Lease
Annual lease payments of R96,700 are made for five years. These payments are tax-
deductible, producing a lease tax shield of (Lease payment × 30%). In Year 5, an additional
purchase option of R33,400 is payable.
After-tax cash flow schedule: Lease
Year Lease Tax Purchase Net Cash Discount Present
Payment Shield Option Flow Factor Value
(30%) (7%)
1 (96,700) 29,010 0 (67,690) 0.9346 (63,263)
2 (96,700) 29,010 0 (67,690) 0.8734 (59,120)
3 (96,700) 29,010 0 (67,690) 0.8163 (55,255)
4 (96,700) 29,010 0 (67,690) 0.7629 (51,641)
5 (96,700) 29,010 (33,400) (101,090) 0.7130 (72,077)
NPV of (R301,356)
Outflows
Result:
The Lease alternative has an NPV of (R301,356).
Alternative 2: Purchase
The purchase option involves:
i) Loan payments of R119,326 per year
ii) After-tax service costs of R8,400
iii) Depreciation tax shield: R24,000
iv) Interest tax shields that decline annually
3|Page
, Elite Academic Institute 068 053 513 262 1185
After-tax cash flow schedule: Purchase
Year Loan Servic Depreciatio Interes Net Discoun Present
Payment e n Tax Shield t Tax Cash t Factor Value
s Costs Shield Flow (7%)
(0.7)
1 (119,326) (8,400) 24,000 18,000 (85,726 0.9346 (80,120)
)
2 (119,326) (8,400) 24,000 15,330 (88,396 0.8734 (77,205)
)
3 (119,326) (8,400) 24,000 12,260 (91,466 0.8163 (74,664)
)
4 (119,326) (8,400) 24,000 8,727 (94,999 0.7629 (72,475)
)
5 (119,326) (8,400) 24,000 4,650 (99,076 0.7130 (70,641)
)
NPV of (R375,105
Outflow )
s
Result:
The Purchase alternative has an NPV of (R375,105).
1.2 Briefly indicate which alternative should be recommended. (2 marks)
Recommendation: Choose the Lease alternative
Reason:
Lease NPV = (R301,356)
Purchase NPV = (R375,105)
The Lease option has a lower present value of cash outflows.
It is therefore the less expensive option by:
R375,105 − R301,356 = R73,749
4|Page
ademic In
Ac sti
te
tu
Eli
te
he
de
W
re a
G ra eM
d u a t e s Ar
Educating the world for a better change
,Elite Academic Institute 068 053 513 262 1185
WARNING: PLEASE NOTE THAT PLAGIARISM IS A SERIOUS ACADEMIC
OFFENSE, therefore, the documents provided here including past assignments, tests and
notes are intended SOLELY for educational purposes and as a guide to help students
understand academic concepts and improve their writing skills. These materials should
not be submitted as final work, as doing so may constitute academic dishonesty. Students
are encouraged to use them as reference points, develop their own understanding and
produce original work that reflects their knowledge and critical thinking. Students are also
encouraged to regenerate their own (personalized) solutions paying particular attention
to module contents as prescribed by module facilitators, lecturers and supervisors. If this
document is plagiarized by the users and fails, ELITE ACADEMIC INSTITUTE should not
be rendered accountable since the contents in this document only give learners a kick-
start on what is expected of them from their areas of specialty.
CAUTION: STUDENTS ARE NOT MANDATED TO USE ALL THE INFORMATION IN
THIS DOCUMENT IN WRITING THEIR ASSIGNMENTS
Educating the world for a better change
,Elite Academic Institute 068 053 513 262 1185
QUESTION 1
1.1 Determine the after-tax cash flows and the net present value of the cash 1.1 1.2
outflows under each alternative. (23 marks)
This analysis compares the Lease and Purchase alternatives using the Net Present Value
(NPV) method, which identifies the option with the lowest present value of cash outflows.
The discount rate is the 7% after-tax cost of debt, and the corporate tax rate is 30%.
Alternative 1: Lease
Annual lease payments of R96,700 are made for five years. These payments are tax-
deductible, producing a lease tax shield of (Lease payment × 30%). In Year 5, an additional
purchase option of R33,400 is payable.
After-tax cash flow schedule: Lease
Year Lease Tax Purchase Net Cash Discount Present
Payment Shield Option Flow Factor Value
(30%) (7%)
1 (96,700) 29,010 0 (67,690) 0.9346 (63,263)
2 (96,700) 29,010 0 (67,690) 0.8734 (59,120)
3 (96,700) 29,010 0 (67,690) 0.8163 (55,255)
4 (96,700) 29,010 0 (67,690) 0.7629 (51,641)
5 (96,700) 29,010 (33,400) (101,090) 0.7130 (72,077)
NPV of (R301,356)
Outflows
Result:
The Lease alternative has an NPV of (R301,356).
Alternative 2: Purchase
The purchase option involves:
i) Loan payments of R119,326 per year
ii) After-tax service costs of R8,400
iii) Depreciation tax shield: R24,000
iv) Interest tax shields that decline annually
3|Page
, Elite Academic Institute 068 053 513 262 1185
After-tax cash flow schedule: Purchase
Year Loan Servic Depreciatio Interes Net Discoun Present
Payment e n Tax Shield t Tax Cash t Factor Value
s Costs Shield Flow (7%)
(0.7)
1 (119,326) (8,400) 24,000 18,000 (85,726 0.9346 (80,120)
)
2 (119,326) (8,400) 24,000 15,330 (88,396 0.8734 (77,205)
)
3 (119,326) (8,400) 24,000 12,260 (91,466 0.8163 (74,664)
)
4 (119,326) (8,400) 24,000 8,727 (94,999 0.7629 (72,475)
)
5 (119,326) (8,400) 24,000 4,650 (99,076 0.7130 (70,641)
)
NPV of (R375,105
Outflow )
s
Result:
The Purchase alternative has an NPV of (R375,105).
1.2 Briefly indicate which alternative should be recommended. (2 marks)
Recommendation: Choose the Lease alternative
Reason:
Lease NPV = (R301,356)
Purchase NPV = (R375,105)
The Lease option has a lower present value of cash outflows.
It is therefore the less expensive option by:
R375,105 − R301,356 = R73,749
4|Page
