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ABC Wines Company is considering the acquisition of a new irrigation system for its extensive vineyards

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ABC Wines Company is considering the acquisition of a new irrigation system for its extensive vineyards;ABC Wines Company is considering the acquisition of a new irrigation system for its extensive vineyards. The system could either be bought outright for ?10 million or via a finance lease requiring three annual payments in advance of ?3.7 million. The leasing company is not the supplier or manufacturer of the equipment.;The new system is expected to give the following pre-tax net cash savings over the existing system in use;Year Pre-tax net cash savings;1 ?6 million;2 ?5 million;3 ?3 million;The system would require replacement in three years? time and have no residual value. The outright purchase would be financed by a loan with an interest rate of 8%.;Assume that corporation tax is charged at 25% and is payable one year in arrears. Writing down allowances is available on the depreciation of the equipment. The company uses the reducing balance method for depreciation at 25%. Lease payments are allowable for tax in full.;The company has no gearing at present and a cost of capital of 13%.;Complete the following;1.Evaluate whether ABC Wines should go ahead with the installation of the new irrigation system and whether they should use the purchase or the lease option. (Tip: You should use NPV to perform the analysis, writing down allowances should be taken into consideration.);2.Explain the primary ways in which finance leases differ from operating leases.

 

Paper#29213 | Written in 18-Jul-2015

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