DELTA Corporation, a producer of refrigerators, is considering to expand its operation by adding new plant & machinery. The cost of the plant and machinery would be Tk. 230 million. The expected life of the plant & machinery is 5 years. The addition of these plant & machinery will result in cash inflows of Tk. 115 million per year for 5 years. Cash outflows would be 50% of cash inflows. DELTA uses straight line method of depreciation and expects no salvage value from the plant&machinery at the end their service life. IDLC, a leading Non-Bank Financial Institution, offered DELTA to lease the plant &machinery for 5 years. The lease payments to be made at the beginning of each year would be Tk. 54million. The annualized risk-free rate of return is 7%. Tax rate for both DELTA Corporation and IDLC is 30%.Show the cash flows associated with theplant&machinery to DELTA if it decides to buy them.Show the cash flows associated with the plant& machinery to DELTA if it decides to take lease on them from IDLC.Show the incremental cash flows for lease versus buy to DELTAof the plant & machinery.Calculate the NPV from the incremental cash flows. If you are the analyst, would you recommend DELTAto take a lease on the plant & machineries from IDLC or buy them?Find out the NPV of the lease of the plant& machinery to IDLC. Show the calculation.Assume now that DELTA Corporation’s tax rate is 10% while IDLC’s tax rate remained at 30% and IDLCrevises its offer to reduce the lease payments to 50 million a year.(i) Now find out the NPVto DELTA and to IDLC of the lease.(ii)Find out the minimum lease payments that IDLC can accept and maximum lease payments that DELTA can accept.

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EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter14: Capital Structure Management In Practice

Section14.A: Breakeven Analysis

Problem 8P

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DELTA Corporation, a producer of refrigerators, is considering to expand its operation by adding new plant & machinery. The cost of the plant and machinery would be Tk. 230 million. The expected life of the plant & machinery is 5 years. The addition of these plant & machinery will result in cash inflows of Tk. 115 million per year for 5 years. Cash outflows would be 50% of cash inflows. DELTA uses straight line method of depreciation and expects no salvage value from the plant&machinery at the end their service life. IDLC, a leading Non-Bank Financial Institution, offered DELTA to lease the plant &machinery for 5 years. The lease payments to be made at the beginning of each year would be Tk. 54million. The annualized risk-free rate of return is 7%. Tax rate for both DELTA Corporation and IDLC is 30%.

Show the cash flows associated with theplant&machinery to DELTA if it decides to buy them.
Show the cash flows associated with the plant& machinery to DELTA if it decides to take lease on them from IDLC.
Show the incremental cash flows for lease versus buy to DELTAof the plant & machinery.
Calculate the NPV from the incremental cash flows. If you are the analyst, would you recommend DELTAto take a lease on the plant & machineries from IDLC or buy them?
Find out the NPV of the lease of the plant& machinery to IDLC. Show the calculation.
Assume now that DELTA Corporation’s tax rate is 10% while IDLC’s tax rate remained at 30% and IDLCrevises its offer to reduce the lease payments to 50 million a year.

(i) Now find out the NPVto DELTA and to IDLC of the lease.

(ii)Find out the minimum lease payments that IDLC can accept and maximum lease payments that DELTA can accept.

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