SCS – Nov 2021 – L3 – Q7a – Sources of Finance

Analyze and recommend the most cost-effective financing option for acquiring 5G equipment: lease or borrow to buy.

Question

The management of COM requires a detailed analysis of the two financing options (borrow to buy or lease) under consideration to determine the cheaper alternative to be used to acquire the 5G equipment. The CFO has been requested to do a presentation at the next Executive Committee (EXCO) meeting.

Required:
You are the CFO, and you are to prepare a presentation to advise EXCO of the cheaper financing option. Your presentation must include detailed computations supporting your advice.
Marks: 15 marks

Answer

Presentation on the Borrow to Buy or Lease Options

Borrow to buy and lease are two common financing options available to a company to finance the acquisition of fixed assets. The present value of the overall costs of the two options is compared, and the option with the lower cost is preferred.

Based on the information provided and the computations below, financing the 5G equipment with the borrow-to-buy option is cheaper by GH¢2.71 million compared to the lease option. Therefore, I will advise EXCO to adopt borrow to buy to finance the intended acquisition of the equipment.

Supporting Computations

1. Evaluation of Borrow to Buy Option

Loan Amount: GH¢150 million
Loan Term: 5 years
Cost of Capital: 20%

Annuity Formula for Annual Repayment:

Where:

$P V$ = Present Value (GH¢150 million)
$r$ = Interest Rate (20%)
$n$ = Number of Years (5)

$PMT = {150,000,000}{2.9906} = GH¢50.16 million$

2. Loan Amortization Schedule

Year	Opening Balance	Interest @ 20%	Repayment	Closing Balance
1	150.00 million	30.00 million	50.16 million	129.84 million
2	129.84 million	25.97 million	50.16 million	105.65 million
3	105.65 million	21.13 million	50.16 million	76.63 million
4	76.63 million	15.33 million	50.16 million	41.80 million
5	41.80 million	8.36 million	50.16 million	0 million

3. Capital Allowance and Tax Savings

Capital Allowance: GH¢150 million $×\times$ 25% = GH¢37.50 million
Tax Savings on Capital Allowance: GH¢37.50 million $×\times$ 25% = GH¢9.38 million

4. Tax Savings on Interest Cost

Year	Interest @ 20%	Tax Savings (25%)
1	30.00 million	7.50 million
2	25.97 million	6.49 million
3	21.13 million	5.28 million
4	15.33 million	3.83 million
5	8.36 million	2.09 million

5. Net Present Value (NPV) of Lease Option

Annual Lease Payment = GH¢48 million
Lease Term = 5 years
Discount Rate = 20%

NPV of Lease = GH¢150.19 million

Conclusion

Based on the present value analysis, the borrow-to-buy option is cheaper by GH¢2.71 million compared to the lease option. Therefore, it is recommended to finance the acquisition of the 5G equipment through the borrow-to-buy option.

Tags: 5G Equipment, Borrow to Buy, Cost Analysis, Financing Options, Lease
Level: Level 3

Topic: Sources of Finance
Series: NOV 2021

Uploader: Dotse