Problem:
Weaving Ltd is the medium-sized Mauritian knitwear company. It assembles jumpers and other forms of knitwear clothing. Despite adverse economic background, Weaving Ltd has been doing well and is seeking to enlarge production.
Weaving Ltd is considering obtaining a new piece of machinery, which will raise production. The company can either buy 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 spur package. The principal and interest will have to be paid back in equivalent instalments over 4 years. The machine costs Rs40 000 and if bought outright, the purchase will take place 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 the straight-line basis. The company faces a tax rate of 15%. The tax regime in force needs companies to pay tax in the year of profit and any tax relief resulting from depreciation can only be claimed by 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:
Assess whether the company must lease or buy the machinery. Your workings must show the Net Advantage of Leasing (NAL).