Fund based

Financial
Services
MODULE 4
RECOMMEND IDEAL FUND BASED FINANCIAL
SERVICES FOR CAPITAL REQUIREMENT
What are we going to learn
❖Factoring: Mechanism-Types- functions- forfeiting – difference between factoring and forfaiting-

❖Bill discounting

❖Leasing : Types of lease – Characteristics

❖Hire Purchase: Legal framework- difference between leasing and hire purchase
Factoring
 Factoring
❖Factoring is a financial technique where a specialized firm (factor)
purchases from the clients accounts receivables that result from
the sales of goods or services to customers.

❖In this way, the customer of the client firm becomes the debtor of
the factor and has to fulfil its obligations towards the factor directly.

❖The factoring agreement usually assumes that the whole credit

risks as well as the collection of the accounts are taken by the factor.

❖Factoring offers enterprises, particularly small and medium ones, a

means of financing their need for working capital, but also an
instrument of collection of receivables and default risk hedging.
 Factoring - Features
❖Factor provides finance for the supplier, including loans and advance payments.
❖Usually the period for factoring is 90 to 150 days. Some factoring companies allow even more than 150
days.
❖Factoring is considered to be a less costly source of finance compared to other sources of short term
borrowings.
❖The fee for factoring is generally around 1 % - 4 % on invoice amount
❖Factoring receivables is an ideal financial solution for new and emerging firms without strong financials.
This is because creditworthiness is evaluated based on the financial strength of the customer (debtor).
Hence these companies can leverage on the financial strength of their customers.
❖Credit rating is not mandatory for factoring. But the factoring companies usually carry out credit risk
analysis before entering into the agreement.
Factoring – Parties (3)
Seller – The company who sells goods / services. They are
also called as the client of the factor

Factor – Who buys the invoices from clients / seller

Buyer – The entity to whom sales are made by the seller.

They are also called debtors
Objectives of Factoring
1. To relieve from the trouble of collecting receivables so as to concentrate in sales and other
major areas of business.

2. To minimize the risk of bad debts arising on account of non realisation of credit sales.

3. To adopt better credit control policy.

4. To carry on business smoothly and not to rely on external sources to meet working capital
requirements.

5. To get information about market, customers’ credit worthiness etc. so as to make necessary
changes in the marketing policies or strategies.
Functions of a Factor
1. Provision of finance:
2. Administration of sales ledger:
3. Collection of receivables:
4. Protection against risk:
5. Credit management:
6. Advisory services:
Advantages of Factoring
1. Improves efficiency:

2. Higher credit standing:

3. Reduces cost:

4. Additional source:

5. Advisory service:

6. Acceleration of production cycle

7. Adequate credit period for customers:

8. Competitive terms to offer:

Factoring - Functions
❖Provide Short term finance: Provide advance up to 80 % to the client.

❖Maintaining accounts: Preparing and updating sales ledger and providing useful reports to clients

❖Provides Advisory Services: Advises the company related to credit worthiness of buyer, potential
customers, markets etc.

❖Provide credit protection: Protects the clients from bad-debts and non payment

❖Provide collection facilities: Collect money on behalf of customers and remits money after reducing
required fee
Factoring – Working mechanism
1 3 5 7
Firstly, the
customer Client Factor makes
places an assigns Factor send balance 20%
order with invoice to statement on realization to
the Client factor to customer client.

Client Factor Customer

sends make pre- make
goods and payment payment to
invoice to up to 80 % factor
customer to client

2 4 6
Factoring - Types
❖Recourse Factoring: The factor does not assume the credit risk (risk of non-payment by the debtors).
In other words, if the receivables become bad, i.e. if the customer does not pay on maturity, risk of bad
receivables remains with the seller, and the factor does not assume any risk associated with the
receivables.

❖Non-Recourse Factoring: The factor assumes the risk of non-payment by the client’s customers. The
factor cannot demand any outstanding amount from the client (seller). The commission or fees charged
for non-recourse factoring services are higher than for recourse factoring. The factor assumes the risk
of non-payment on maturity and consequently takes an additional fee called a del credere commission.

❖Advance factoring: In this, advance is paid to the client by factor against uncollected receivables.

❖Maturity factoring: In this, bank collects money from the customer and pays to firm on due date or
before.
Factoring - Types
❖Domestic Factoring: In domestic factoring three parties are involved (the seller, the buyer, and the
factor). In domestic factoring, the factor mediates between the seller and the buyer. All three parties
are located in the same country.
❖Export Factoring: Export factoring is similar to domestic factoring, except there are four parties
involved. There are consequently two factors involved in the transaction, and it is referred to as the
two-factor system of factoring.
❖Full Factoring: In full factoring, the factor performs almost all services of collection of receivables,
maintenance of sales ledger, credit collection, credit control and credit insurance.
❖Disclosed factoring: If factor name is represented on the invoice of the goods or services and asks
customer to pay the factor.
❖Undisclosed factoring: Factor is not mentioned on the invoice of the goods or services by
manufacturer.
Forfaiting
Forfaiting
❖Forfaiting is a method of obtaining long to medium-term funds for a business involved in
international trade. The process consists of a company engaged in exporting the capital
goods, selling foreign accounts receivables like promissory notes or bills of exchange, and
immediately receiving the financing.
❖It is a method of export financing
❖Many exporters pursues sales including foreign buyers
❖A trade finance option exporters use to get immediate cash after shipment
❖Eliminates all kinds of risk but fees are very high
❖They are used by well established large and medium size companies
Forfaiting
❖It is another variant of Factoring

❖Forfaiting is a method of trade financing. In this process, exporters sell their foreign receivables,
either for a long-term or a medium-term, to a forfaiter at a discount.

❖The forfaiter then gets the sum due from the importer on the contracted payment date.

❖A forfaiting transaction occurs on a non-recourse basis. The term ‘non-recourse’ here means that the
forfaiter has no right to recover payment from the exporter in case of default by the importer.

❖Forfeiting is appropriate for expensive exports to eliminate risk of default in payment

Forfaiting - Process
1. Exporter / Seller 2. Exporter
3. Exporter presents
communicates with approaches Forfaiter
transaction details to
prospective imported / before pricing
forfaiter
buyer negotiation with buyer

4. Forfaiter evaluates
5. Exporter present 6. Receive guarantee of
transaction and
financing proposal to payment from a bank in
determines price and
importer the importer’s country
sign commitment letter

7. Shipping the goods

to importer after 8. Forfaiter pays 9. Forfaiter collects the
signing sales contract money immediately to future payments from
and endorses the exporter the importer
negotiable instruments
• Parties to Forfaiting:
• Exporter
• Importer
• Forfaiter (Ex)
• Bank (Imp.)
Forfaiting - Charges
1. Commitment Fees:
◦ The lender is compensated for providing access to a potential loan through a commitment fee since it has set
aside the funds for the borrower and cannot yet charge interest. 0.5 – 1.5 % of the transaction value

2. Discount Fees:
◦ It is the interest cost payable by the exporter for the entire period of the credit involved
◦ It is deducted by the forfaiter from the amount paid to the exporter against the availed promissory
notes or bills of exchange

3. Documentation Fees:
◦ If extensive documentation is involved & a legal framework is necessary, a documentation may be changed.
Forfaiting – Charges – Small Example
Suresh Ltd. plans to sell a machine from India to Jack LLP in Canada. The proposed selling price is Rs.
5,00,00,000. After the evaluation of Forfaiter, they decided to increase the price to an extent of 6 %.
Buyer agreed and transaction is about to start. Imagine that the commitment fee is 0.8 %; discount fee
is 5 % and documentation fee is 0.4 %. of the actual selling price Find out the three fees.

1. Commitment Fees:

2. Discount Fees:

1. Documentation Fees:
Forfaiting – Charges – Small Example
Pricol Ltd. (India) plans to sell goods worth Rs. 10 crore to GM Motors (Canada). Repayment tenure is
for 7 years. Pricol approaches a forfaiter to get the dues. After the process the fee charges are as: (1)
Commitment 1 %, (2) Discount 6 %, (3) Documentation - nil. Find out the fees and compute the amount
received by Pricol from the Factor.

1. Commitment Fees:

2. Discount Fees:

1. Documentation Fees:
Bill Discounting
Bill Discounting
❖Bill Discounting is a trade-related activity in which a company’s unpaid invoices which are due to be
paid at a future date are sold to a financier (a bank or another financial institution).

❖Bill Discounting is the process of trading/ selling the bill of exchange/ invoice to the financial
intermediary to avail funds prior to its maturity date against a fees/ interest paid to the finance
company.

❖In simple words, we can say the bill discounting is a source of working capital financing for micro,
small and medium type enterprises.

❖The business is responsible to collect unpaid invoices during maturity. Bills discounting only act as a
source of immediate working capital requirement.
Bill Discounting – Process
• The seller/ exporter sell the goods or services and raise the bill/ invoice to the
Selling & Raising invoice: buyer/ importer.

• The buyer receives the goods and sign/ accept the invoice raised. This means buyer
Buying and accepting bill: obligate to pay the entire amount as per invoice to the seller on the due date.

• The seller approaches his bank or concerned financial institutions with the
Seller approaches bank: accepted bill of exchange by the buyer to discount it.

• The banks examine the bill of exchange and evaluate the risk involved as per their
Bank examining bill: norms.

Transferring amount to • Finally, the banks will transfer the money to the seller’s account after deducting
seller: their charges/ interest.

Buyer pays bank on due • Further on the due date, the seller’s bank receives the entire amount from the
date: buyer/ buyer’s bank.
Bill Discounting – Process
Bill Discounting – Benefits
❖Reducing the chance of bad debt: Bill discounting reduces the chances of bad debt as the risk of
defaults or non-payment by the buyer/ importer is bored by the intermediary institutions.

❖Improves cash flow: It facilitates the seller to improve the cash inflow and hence avoid cash crunch
during a trade.

❖Cheaper: Typically bill discounting services are provided on a low rate of interest/ fees as compared
to other advanced facilities, therefore, beneficial for sellers.

❖Negotiable and liquid: Since the bill of exchange is a negotiable/ tradable instrument and can be
further rediscounted by the central banks or can be sold to other financial institutions hence
processed quickly. Thus seller will be able to instant backup of funds.
Bill Discounting – Find out
❖A business owner sells goods to Mr. X worth Rs. 20,000 on credit but Mr. X agrees to pay after two
months of purchase. However, the business owner is in urgent need of funds and can’t wait for two
months. Therefore, business owner can discount the bill with the bank for two months before its due
date. For example, if the same trader discounts his bill(s) with a bank offering discount rate @ 12%
p.a. What is the amount, he would receive from the bank?

❖Sukumara Kurup Ltd. sold goods to Chacko worth Rs. 5,00,000 with a credit period of 6 months.
However, the seller cannot afford to wait till 6 months to get the payment. Seller approaches ICICI
bank which would provide invoice discounting service at a discount rate of 15% p.a. Calculate the
amount receivable from the bank.
Factoring Vs Bills Discounting
Leasing
❖Lease finance can be said to be a “contract between lessor and lessee whereby the
former acquires the equipment/goods/plant as required and specified by the lessee and
passes on the goods to the lessee for use for a specific place and in consideration
promises to pay the lessor a specified sum in a specified mode at specific interval and at a
specified place”. [Contract, Lessor, Lessee, Without transfer of ownership]

❖Under the lease financing, an asset can be acquired without incurring the initial
purchase cost by just making payment of lease rentals over a specified period of the lease
contract. [Without initial high cost of purchase]

❖The lease transaction may be broadly equated to an installment credit being extended to
the person using the asset by the owner of the asset, but without transferring the title of
ownership. [Lease rental charged by lessor to lessee]
Leasing terms
❖Lessor – Owner of the asset

❖Lessee – User of the asset is called as lessee

❖Lease rental – Periodic or lumpsum payment made by lessee to the lessor

❖Right to the lessee – Right to use

❖Right to the lessor – Ownership

❖After leaser period ends – Lessee can:

❖Return the asset
❖Purchase the asset
❖Renew lease agreement
Leasing - Features
❖Financial contract: A lease is a financial contract which is enforceable by law

❖Two parties: Two parties are - Lessor and Lessee

❖Term of lease: Lease term is much lower than economic life of the asset

❖Rights: Lessee has right to terminate lease by giving short notice and no penalty can be
charged

❖Technical knowhow: Lessor provides technical knowhow of the leased asset

Leasing - Features
❖Owner: Equipment is purchased by the lessor and he is the owner

❖Rights of lessee: Lessee has the right to possess the equipment.

❖Period: It is for a specific period of time.

❖Benefit for lessor: Lessee have to pay some lease rentals to the lessor.

❖Depreciation: Lessor or lessee takes depreciation and income tax benefits. (Based on type
of lease)
Leasing - Types
Financial
Lease

Types
Leveraged Operating
lease of Lease
leasing:

Sales and
Leaseback
 Leasing - Types
❖Financial Lease: Financial lease refers to the lease which is for long term duration, it means period takes place
the same as the life of an asset.
❖The lease amount covers the capital cost of the lessor and a small return
❖This financial lease cannot be canceled, the lessee has to make a series of payment for the use of an asset.
❖ Lessee possess that asset without having any title.
❖In other words, there is no transfer of title in the initial period of lease in the financial lease.
❖Rest life of equipment is equal to the scrap value where lessor does a contract to sell his asset to the lessee at
scrap value and transfer his title to the lessee.

❖Operating Lease: Operating lease is somehow the same as financial lease.

❖Operating lease for short term duration and power of lessor to control on the asset is more than lessee.
❖When the lessor is a manufacturer, who wants to boost up his sales in short term, so he allows customers to
possess the asset for a short period of time.
Benefits of Financial lease
❖There is less upfront cash outlay: No need to make large cash payments for the purchase of needed
equipment.

❖Leasing better utilizes equipment: Lease and payment for equipment is only for the time when
need of it.

❖Upgradation possibility: As new equipment becomes available company can upgrade to the latest
models each time when lease ends.

❖Better financing: It is easier to obtain lease financing than loans from commercial lenders.

❖Tax benefits: It offers potential tax benefits depending on how the lease is structured.
 Basis Operating Lease Financial Lease
Ownership of the asset lies with the lessor after the Ownership of the asset can be transferred to the lessee
Ownership
lease term. at the end of the lease term

Purchase option There is no bargain purchase option available. Bargain Purchase option is available

A lease is considered as an operating lease if the lease For a lease to be classified as financial lease, the lease
Value of asset Term is for a period less than 75% of the estimated period should be at least 75% of the estimated
life economic life.
There is no risk associated with ownership of the
Risk of ownership The risk of ownership of the asset lies with the lessee.
asset.
Lease payments are considered to be a rental Since financial lease is a capital expenditure, it is
Rental accounting
expense from the perspective of tax. treated as such from the perspective of tax.
Operating Lease is considered to be a short term Financial lease is normally a long term financing
Term of horizon
arrangement. arrangement.

Under the financial lease, the ownership belongs to the

Under an operating lease, maintenance is mostly
lessee, hence, he is required to pay for maintenance of
Maintenance responsibility undertaken by the lessor, unless stated otherwise.
the asset. Lessee is also required to depreciate the asset
Depreciation is also undertaken by the lessor.
in their books.
Leasing

3. Sale and lease back 4. Leveraged Lease

Leasing - Types
❖Sales and Leaseback: In this lease, the first lessee purchases the equipment on his own and then he
sells it to the lessor or to its firm.
❖Long duration: Applied when the owner owns the asset for fairly long duration of time
❖Liquidity crunch: This lease is popular because when the lessee facing any liquidity problems from an asset.
❖Cash inflow: Then, he can sell his equipment to the lessor and get it back from them. This will help lessee in sort
out the liquidity issue without parting with it.

❖Leveraged Lease: Leveraged lease refers to a lease agreement wherein the lessor acquires an asset
partially financed by the financial institutions and lease out the same to the lessee for the agreed lease
payments.
❖Lessee pays to bank: The lessee transfer the lease rentals directly to an escrow account maintained with the
financial institution by the lessor.
❖Bank transfers to lessor: The financial institution charges the loan installments (principal as well as interest)
from the proceeds available in the escrow account and balance amount if any gets transferred to the account of the
lessor.
Other types of leasing
Direct

leasing Under direct leasing, a firm acquires the right to use an asset from the manufacture
directly. The ownership of the asset leased out remains with the manufacturer itself. The major
types of direct lessor include manufacturers, finance companies, independent lease companies,
special purpose leasing companies etc.

Full Payout Lease:

A lease in which the lessor recovers, through the lease payments, all costs incurred in the lease
plus an acceptable rate of return, without any reliance upon the leased equipment's future
resi’ual value.
Guideline Lease:
A lease written under criteria established by the IRS to determine the availability of tax benefits to the
lessor.

Net Lease: A lease wherein payments to the lessor do not include insurance and maintenance, which are
paid separately by the lessee.
Open-end Lease:
A conditional sale lease in which the lessee guarantees that the lessor will realize a minimum value from
the sale of the asset at the end of the lease.
Sales-type Lease: A lease by a lessor who is the manufacturer or dealer, in which the lease meets the
definitional criteria of a capital lease or direct financing lease.
Synthetic Lease: A synthetic lease is basically a financing structured to be treated as a lease for
accounting purposes, but as a loan for tax purposes. The structure is used by corporations that are
seeking off-balance sheet reporting of their asset based financing, and that can efficiently use the tax
benefits of owning the financed asset.
LEASE AGREEMENT
This Lease Agreement is made and executed on this ______ day of ______ at ________________________ by
and between :
Sri ________________________ S/o D/o W/o____________ ____________ aged about ____________
Occupation __________________ R/ o _________
______________________________________________________
Represented by his / her agent
Being minor represented by Father/Mother/Brother/Guardian
Sri____________________ S/o, D/o, W/o. ____________________,
aged about __________ years, Occupation: ___________________
Residing at under general / special
power of attorney dated________ Registered as Document
Number_____ of Year_____ Book - I / IV of RO/SRO__________.

(Hereinafter called the Landlord or Lessor which term shall mean and include all their heirs, legal,
representatives, nominees and assigns etc.).
Sri ________________________ S/o D/o W/o____________ ____________ aged about ____________
Occupation __________________ R/ o _________
______________________________________________________
Being minor represented by Father/Mother/Brother/Guardian
Sri____________________ S/o, D/o, W/o. ____________________,
aged about __________ years, Occupation: ___________________
Residing at___________________.

Hereinafter called the lessee which term shall mean and include all his heirs, legal representatives, nominees
and assignees etc.
Whereas the land lord herein is absolute owner of the House bearing No. __________ in Survey No.
__________ constructed on Plot No.______ situated at ________________Village, _______________Mandal,
__________District, which was inherited / having acquired through a Sale/Gift/Gift Settlement/Partition/Will deed
registered as Document No.______________ of S.R.O. ____________________ copied in Volume No.
____________________ at Page ____________.
Whereas the Lessee has approached the lessor and offered to take on lease the scheduled property belonging to
the lessor and the lessor has agreed to lease the scheduled on terms and conditions as here under.
NOW THIS AGREEMENT WITNESSETH AS UNDER :
The lease shall be for a period of ______________ months / years
1. That the lessee shall pay a monthly rent of Rs. ______________ (Rupees ____________________________
only) exclusive of property tax, electricity charges, maintenance charges and any other charges to the land lord
on or before ____ day of every English Calander month without any default. The payment of monthly rent shall
be witnessed by duly stamped receipt evidently payment of rent.
A) The Lessee paid of Rs__________ months rent to the lessor as deposit,
which is adjustable before the termination of the lease.
b) The lessee paid _______ months rent as deposit to the lessor which is refundable at the time of termination of
lease. (either a or b)
That the lessee shall pay apart from the aforesaid rent, water charges, maintenance charges and any other
charges levied by the government authorities regularly.The property tax to local body will be paid by the lessor
only (either 4 or 5)The property tax to local body will be paid by the lessee and the present property tax is
Rs_________ per annum.That the lessee shall obtain receipts for the property tax paid and submit to the
lessor.That the lessee shall not sublet the premises or transfer his lease hold rights in favour of any person
whatsoever. The lessee shall not part with the possession of either whole or in portion of the leased premises in
favour of any person whatsoever.That the lessee shall keep the scheduled property in good condition and shall
not carry or any alteration what so ever. Without the prior written consent of the landlord.That the lessee shall not
carry on any illegal business or shall store any material prohibited under law.That the lessee shall not store any
explosive material which may damage the schedule property .That the lessor and its representatives shall be
entitled to inspect the schedule property at all reasonable times.That in the event of the lessee committing breach
of any of the terms and conditions mentioned above. The lessor shall be entitled to terminate the leaseagreement
without any notice and take possession of the leased property.That the lessee shall pay the rent every month
regularly before the _______ of the each succeeding month and obtain the receipt of the same.The scheduled
property is not an assigned land within the meaning of A.P.Assigned lands (Prohibition of Transfers) Act 9 of
1977 and it does not belong or under mortgage to Govt.agencies / undertakings.Annexure 1A to be attached to
the document.

SCHEDULE OF PROPERTY
All that the piece and parcel of house admeasuring ________________ sq. yards or __________ sq. mts
consisting of _________ sft of built up area_____ floor with_______, bearing Door Number __________ situated
in Ward No.________ Block No.__________ in _________ Corporation / Municipality _________ Village
________Sub District _______Registration District bounded by:
North :
South :
East :
West :
In witness whereof the landlord and the lessee have signed this lease agreementin token of their acceptance with
their own free will and without any undue influence and coercion in the presence of witnesses :
WITNESSES : LESSOR
1.
2. LESSEEE
Lease or buy evaluation – Problem 1
A limited company is interested in acquiring the use of an asset costing Rs. 5,00,000. It has two options:

(i) To borrow the amount at 18% p.a. repayable in 5 equal installments or

(ii) To take on lease the asset for a period of 5 years at the year end rentals of Rs. 1,20,000.
The corporate tax is 50% and the depreciation is allowed on w.d.v. at 20%. The asset will have a salvage of Rs.
1,80,000 at the end of the 5th year.

You are required to advise the company about lease or buy decision.

(1) The present value of Re. 1 at 18% discount factor is:

• 1st year – .847
• 2nd year – .718
• 3rd year – .609
• 4th year – .516
• 5th year – .437
(2) The present value of an annuity of Re. 1 at 18% p.a. is Rs.
3.127.
Step – 1 – Find out loan instalment
Loan instalment = Loan amount / P.V. Factor of annuity

= 5,00,000 / 3.127

= Rs. 1,59,898 (Approx.)

Why are we doing?

To calculate principal and interest using Time value of money for 5 years EYI
Step 2 – Prepare schedule of loan
payment
Loan Balance Loan Loan balance
Interest Principal
Year (Beginning of instalment (End of the
payment payment
the year) (Int + Princi) year)
Step 2 – Prepare schedule of loan
payment
Step 3 – Prepare schedule of
depreciation
Opening
Depreciation Closing
Year Balance of
(WDV 20 %) Balance
machine
Step 3 – Prepare schedule of
depreciation
Opening
Depreciation Closing
Year Balance of
(WDV 20 %) Balance
machine
1 500000 100000 400000
2 400000 80000 320000
3 320000 64000 256000
4 256000 51200 204800
5 204800 40960 163840
Step 4 – Calculation of PV after tax cash
outflow – BUYING option
Tax saving (50 %)
Year Loan Net cash PV factor PV of cash
end instalment Interest Depreciat Total outflow at 18 % outflow
ion
Col. 1 2 3 4 = 2-3 5 6
Step 4 – Calculation of PV after tax cash
outflow – BUYING option
Step 5 – Calculation of PV after tax cash
outflow – LEASING option
Year end PV factor of Loan balance
Tax savings After tax cash
(Period of Lease rental annuity at 18 (End of the
(50%) outflow
leased years) % year)
Step 5 – Calculation of PV after tax cash
outflow – LEASING option
Step 6 – Compare the values
Whichever value is lesser. Go with it.

Leasing: Rs. 1,87,620

Buying: Rs. 2,06,684
In this case, leasing is better.
 Lease or buy evaluation – Problem 2
A limited company is interested in acquiring the use of an asset costing Rs. 5,00,000. It has two options:

(i) To borrow the amount at 14% p.a. repayable in 5 equal installments or

(ii) To take on lease the asset for a period of 5 years at the year end rentals of Rs. 1,20,000.

The corporate tax is 50% and the depreciation is allowed on w.d.v. at 20%. The asset will have a salvage of Rs.
2,20,000 at the end of the 5th year.

You are required to advise the company about lease or buy decision.

Additional info: PVIF

Period
(14%)
The annuity PV factor at the end of 5th year is 3.433 1 0.877
.
2 0.769
3 0.675
4 0.592
5 0.519
Step – 1 – Find out loan instalment
Loan instalment = Loan amount / P.V. Factor of annuity

= 5,00,000 / 3.433

= Rs. 1,45,645 (Approx.)

Why are we doing?

To calculate principal and interest using Time value of money for 5 years EYI
 Step 2 – Prepare schedule of loan
payment
Loan
Loan
instalmen
Balance Interest Principal
Year t Loan balance (End of the year)
(Beginning payment payment
(Int +
of the year)
Princi)
 Loan Balance Loan balance
Loan Interest Principal
Year (Beginning of (End of the
instalment payment payment
the year) year)
1 500000 145645 70000 75645 424355
2 424355 145645 59410 86235 338120
3 338120 145645 47337 98308 239811
4 239811 145645 33574 112071 127740
5 127740 145624 17884 127740 -
Step 3 – Prepare schedule of
depreciation
Opening
Depreciation Closing
Year Balance of
(WDV 20 %) Balance
machine
 Opening Depreciati
Closing
Year Balance of on (WDV
Balance
machine 20 %)
1 500000 100000 400000
2 400000 80000 320000
3 320000 64000 256000
4 256000 51200 204800
5 204800 40960 163840
Step 4 – Calculation of PV after tax cash
outflow – BUYING option
Tax saving (50 %)
Year Loan Net cash PV factor PV of cash
end instalment Interest Depreciat Total outflow at 14 % outflow
ion
Col. 1 2 3 4 = 2-3 5 6
 Tax saving (50 %)
Year Loan Net cash PV factor PV of cash
end instalment outflow at 14 % outflow
Depreciati
Interest Total
on
Col. 1 2 3 4 = 2-3 5 6
1 145645 35000 50000 85000 60645 0.877 53186
2 145645 29704.85 40000 69705 75940 0.769 58398
3 145645 23668.379 32000 55668 89977 0.675 60734
4 145645 16786.802 25600 42387 103258 0.592 61129
5 145624 8941.8043 20480 29422 116202 0.519 60309
Total 293756
Less Salvage (220000 * 0.519)
114180
179576
Step 5 – Calculation of PV after tax cash
outflow – LEASING option
Year end PV factor of
Tax savings After tax cash Total PV of
(Period of Lease rental annuity at 14
(50%) outflow cash out flow
leased years) %
 Year Loan
Tax After tax PV factor Total PV
end Lease balance
savings cash of annuity of cash
(Period rental (End of the
(50%) outflow at14
at 18%
% out flow
of year)
1 to 5 120000 60000 60000 3.433 205980
Step 6 – Compare the values
Whichever value is lesser. Go with it.

Mode Rs.
Leasing 205980
Buying 179576

Buying option will be better

Lease or buy evaluation – Problem 3
A limited company is interested in acquiring the use of an asset costing
Rs. 4,00,000. It has two options:
(i) To borrow the amount at 9 % p.a. repayable in 5 equal installments or
(ii) To take on lease the asset for a period of 5 years at the year end rentals of
Rs. 1,50,000
The corporate tax is 30% and the depreciation is allowed on w.d.v. at 10%.
The. asset will have a salvage of Rs. 2,20,000 at the end of the 5th year.
You are required to advise the company about lease or buy decision.
Step – 1 – Find out loan instalment
Loan instalment = Loan amount / P.V. Factor of annuity

= 4,00,000 / 3.890 = 1,02,828 (Approx)

Why are we doing?

To calculate principal and interest using Time value of money for 5 years EYI
 Step 2 – Prepare schedule of loan
payment
Loan
Loan
instalmen
Balance Interest Principal
Year t Loan balance (End of the year)
(Beginning payment payment
(Int +
of the year)
Princi)
Step 3 – Prepare schedule of
depreciation
Opening
Depreciation Closing
Year Balance of
(WDV 10 %) Balance
machine
 Step 4 – Calculation of PV after tax cash
outflow – BUYING option
Tax saving (30 %)
Year Loan Net cash PV factor PV of cash
end instalment Interest Depreciat Total outflow at 9 % outflow
ion
Col. 1 2 3 4 = 2-3 5 6
Step 5 – Calculation of PV after tax cash
outflow – LEASING option
Year end PV factor of
Tax savings After tax cash PV of total
(Period of Lease rental annuity at 9
(30%) outflow cash outflow
leased years) %
Step 6 – Compare the values
Whichever value is lesser. Go with it.
 Lease or buy evaluation – Problem 4
A limited company is interested in acquiring the use of an asset costing Rs.
6,00,000. It has two options:

(i) To borrow the amount at 11 % p.a. repayable in 6 equal installments or

(ii) To take on lease the asset for a period of 6 years at the year end rentals of Rs.
1,80,000

The corporate tax is 30% and the depreciation is allowed on straight line at 10%. The
asset will have a scrap of Rs. 2,50,000 at the end of the 6th year.

You are required

. to advise the company about lease or buy decision.

4.231 is the PV factor annuity of 11% and 6 years

Step – 1 – Find out loan instalment
Loan instalment = Loan amount / P.V. Factor of annuity

= 6,00,000 / 4.231 = 1,41,810 (Approx)

Why are we doing?

To calculate principal and interest using Time value of money for 6 years EYI
 Step 2 – Prepare schedule of loan
payment
Loan
Loan
instalmen
Balance Interest Principal
Year t Loan balance (End of the year)
(Beginning payment payment
(Int +
of the year)
Princi)
Step 3 – Prepare schedule of
depreciation
Opening
Depreciation Closing
Year Balance of
(SLM 10 %) Balance
machine
 Step 4 – Calculation of PV after tax cash
outflow – BUYING option
Tax saving (30 %)
Year Loan Net cash PV factor PV of cash
end instalment Interest Depreciat Total outflow at 11 % outflow
ion
Col. 1 2 3 4 = 2-3 5 6
Step 5 – Calculation of PV after tax cash
outflow – LEASING option
Year end PV factor of
Tax savings After tax cash PV of total
(Period of Lease rental annuity at 11
(30%) outflow cash outflow
leased years) %
Step 6 – Compare the values
Whichever value is lesser. Go with it.
 Lease or buy evaluation – Problem 5
A limited company is interested in acquiring the use of an asset costing Rs.
3,00,000. It has two options:

(i) To borrow the amount at 12 % p.a. repayable in 4 equal installments or

(ii) To take on lease the asset for a period of 4 years at the year end rentals of Rs.
1,00,000

The corporate tax is 30% and the depreciation is allowed on straight line at 5%. The
asset will have a scrap of Rs. 2,45,000 at the end of the 6th year.

You are required

. to advise the company about lease or buy decision.
Till now what we have learnt:
Factoring
• Selling the entire books of accounts to factor
• Main types – Recourse & Non-Recourse
Forfaiting
• Factoring in an international environment

Leasing
• Agreement to create a right to use asset
• Main types: Operating, Financial, Sales & leaseback, Leveraged
Next What?
Hire purchase
 Hire purchase
Hire purchase is an arrangement for buying expensive consumer goods, where the buyer makes an initial
down payment and pays the balance plus interest in installments.

In a hire purchase agreement, ownership is not transferred to the purchaser until all payments are made.

Hire purchase agreements usually prove to be more expensive in the long run than purchasing an item
outright.

The use of HP is particularly common in industries where expensive machinery is required, such as
construction, manufacturing, plant hire, printing, road freight, transport, engineering and professional services.

It is also used to finance other capital requirements of a business including: Smaller items, cars, photocopiers
etc.

The asset provider usually dictates this type of linked finance.

Hire purchase - Terminologies
Hire vendor: Person who delivers the goods along with its possession under hire purchase agreement.
E.g. Indian Overseas Bank

Hire Purchaser: Person who obtains the goods and right to use the goods. E.g. Mukund S

Cash Price: Amount to be paid by buyer if outright purchase is in cash Rs. 5,85,000

Down Payment: Payment made to hire vendor at the time of entering into hire purchase agreement
E.g. Rs. 1,00,000

Hire purchase installment: Amount to be paid by hire purchaser in periodic intervals up to certain
period specified in the agreement to obtain the ownership of the asset purchased E.g. Rs. 7,803

Hire Purchase price: Total sum payable by hire purchaser to obtain ownership (Cash price + Interest)
E.g. Rs. 6,36,000 (4,85,000 + Interest)
Hire purchase - Benefits
Reduced initial cost: HP allows companies to control and deploy assets without significant drain on
working capital

Fixed EMI: Fixed-rate funding makes budgeting easy as the hire purchaser has clear sight of future
expenditures

Easy possession: Since the initial financial commitment is reduced, it is easy to acquire various asset
class and its ownership without any issue

High accessibility: High accessibility of financing for businesses due to the financing being secured
with the leased asset and the asset being owned by the financing company
Hire purchase - Drawbacks
Total cost increases: total sum of capital payments for HP or leasing will be higher than the full
payment on the asset purchase

Long duration: The period of hire purchase will be for long duration resulting in the cost of interest to
be going up

Administrative complexity administrative complexity and costs will be greater if any covenants are
applied to the arrangement - for example, updates on change of equipment locations

Ownership at the end: Ownership of the asset would take place only after the payment of last EMI.
Hire purchase Vs Leasing
Hire purchase - Calculation
Corona Ltd. Is planning to purchase a car for their company on a hire purchase mode. The following
details are given related to the transaction:

oEx-Showroom Price of the car: Rs. 5,00,000

oTax, RTO, Insurance and misc. – Rs. 85,000

oDown payment – Rs. 1,00,000

oFunding – On-road 100%

oInterest rate – 5 % p.a. fixed

oHire purchase tenure – 7 years

You are required to compute the interest to be paid (in total) and the EMI for the car
Hire purchase - Calculation
Ajmi Foods is planning to purchase a Bharat Benz 2823 truck for their delivery purposes

oEx-Showroom Price BB 2823: Rs. 37,80,000

oTax, RTO, Insurance and misc. – Rs. 6,20,000

oFunding – On-road 75%

oInterest rate – 3 % p.a. fixed

oHire purchase tenure – 5 years

You are required to compute the total cash outflow for the company due to payment of principal and
interest after EMI tenure and the EMI for the truck