Case on Leasing

Ceramics Ltd is considering investment in balancing equipment about which the

following information is available

 The equipment cost Rs 40.8 lakhs exclusive of CST at 2%

 The acquisition will be funded with a mix of term loan and own funds in the
ratio of 3:1 . The loan carries a rate of interest at 12% per annum and the
principle is to be paid back in 5 equal installment
 The planning horizon for such investment is five years . After 5 years the
equipment is expected to fetch a net salvage value of Rs 4 lakhs
 The tax relevant rate of depreciation is 20%
 The investment is expected to generate an incremental EBDIT of Rs 35
Lakhs in year 1, Rs 20 lakhs in year 2 and Rs 12 Lakhs from year 3 to 5

The company has received an offer from Classic leasing ltd, the terms of which are
as follows:

Primary lease period 5 years

Secondary lease period 3 years

Management Fees 1% of Investment cost

Annual Rental

During primary period Rs 294 per Rs Thousand

During Secondary period Rs 36 per Rs Thousand

The lease rentals are payable annually and in arrears. The management fees is
payable immediately on signing the lease

The lease rentals are subject to the applicable service tax The CST for the leasing
company will be 4%

Royal Ceramics has explicitly stated target debt equity ratio of 2:1. The marginal cost
of debt & equity are 15% and 20% respectively

The marginal rate of tax is 30% including surcharge

Based on economic consideration which alternative will you recommend