Problem1. Weaving Ltd is medium-sized Mauritian woollen garments company. It assembles jumpers and other forms of knitwear clothing. Despite the adverse economic background, Weaving Ltd has been doing well and is seeking to expand production.
Weaving Ltd is considering obtaining a new piece of machinery, which will raise production. The company can either purchase the machinery or lease it. If it purchases the machinery, it will have to borrow the cash required. The company can borrow at a rate of 8% under the medium term stimulus package. The principal and interest will have to be paid back in equal instalments over four year. The machine costs Rs40 000 and if purchased outright, the buy will occur at the start of year 1. The machine will have a useful life of 4 years and will be depreciated down to zero value on a straight-line basis. The company faces a tax rate of 15%. The tax regime in force requires companies to pay tax in the year of profit and any tax relief resulting from depreciation can only be claimed by the legal owner of the asset. If the company leases the machine, it will have to make 4 annual lease payments of Rs11, 000 starting one year from now.
Required:
Question1. Evaluate whether the company must lease or purchase the machinery. Your workings must show the Net Advantage of leasing (NAL).
Question2. Briefly explain FOUR factors Weaving Ltd would take in consideration before deciding on the level of debt in its capital structure.