Expert Answer :IT CKIT 551 – ABC Wines Company is considering

Solved by a verified expert :Question 1ABC Wines Company is considering the acquisition of a new irrigation system for itsextensive vineyards. ABC Wines could either buy the system outright for £10 million orsecure a finance lease requiring three annual payments in advance of £3.7 million. The leasingcompany 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 existingsystem in use:Year 1 £6 million2 £5 million3 £3 millionThe system would require replacement in 3 years’ time and have no residual value. Theoutright purchase would be financed by a loan with an interest rate of 8%.Assume that corporation tax is charged at 25% and is payable 1 year in arrears. Writing downallowances are available on the depreciation of the equipment. The company uses thereducing balance method for depreciation at 25%. Lease payments are allowable for tax infull.The company has no gearing at present and a cost of capital of 13%.Required Evaluate whether or not ABC Wines should install the new irrigation system andwhether it should use the purchase or the lease option. (Tip: You should use NPV toperform the analysis, and you should take into consideration writing downallowances.) Explain the primary ways in which finance leases differ from operating leases. Question 2ABC Ltd. produces an MP3 player. The market for this product is increasing, and for thisreason, ABC is planning to expand its production capacity. This plan requires new machineryand an increase in working capital that would be financed by borrowing.Required What are the main sources of finance that can be considered? What are the main factors that should be taken into consideration when deciding onthe mix of long-term and short-term borrowing necessary to finance the expansion? Identify and explain the major factors that a bank would take into account beforedeciding whether to grant a loan to ABC.