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 the plant & 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 a 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 Tk. 50 million a year.
(i) Now find out the NPV to 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.
