`e^mqbo=T=

=
plro`bp=lc=`^mfq^i=Ó=m^oq=f=
jbafrj=^ka=ilkd=qboj=cfk^k`b

After studying this chapter, you should be able to display a good understanding of the
following sources of medium and long term finance:

Ordinary shares

Preference Shares

Retained Earnings

Debt finance

Leasing finance

Venture Capital

Government Grants

Franchising

=
TKM== fkqolar`qflk=

From your early experience with life you might have learnt that money is a scarce resource.
This reality is not only true for individuals like you and me but for businesses as well.
Accordingly, to obtain money, a business has to compete for it. Thus, individuals, the
government and other businesses all seek money to finance their needs. Those with money
to lend will lend it provided the rate of return (interest), the risk and flexibility (how quickly
the money can be repossessed) are consistent with their expectations. Individuals or
organisations that lend money, expect to get their money back, with a fixed annual return
in a comparatively short time. Those who invest in a company become part-owners - share
holders. They expect regular payment of cash dividends (whose size varies with the
company's success) plus an increase in the value of their shares. A major source of finance
for many businesses is the retained profit from sales to customers. A business just starting
up or one expanding rapidly has to raise its finance from other sources.

The plain truth is that without money, no business can survive or exist. In fact companies
are in business to make money. Therefore, whatever happens, the company will always
require money to fund its various projects and ventures and one of the most fundamental
functions or roles of the finance manager is to look for resources on behalf of the
shareholders to run the operations of the company. Money is needed throughout a
company's life. However, the type and amount of finance required for a business depends
on many factors such as the type of business, success of the business and perhaps the state
of the economy. There are two main types of money that a company needs.

- 180 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
TKMKN== `~éáí~ä=ÉñéÉåÇáíìêÉ==

Finance for capital expenditure is used for buying fixed assets where large sums of money
are involved but they are not purchased often such as new premises and machinery.

TKMKO== tçêâáåÖ=Å~éáí~ä=

Working capital is money required for day to day running of the business. This includes
money required to pay salaries and buy stocks for resale.

For many businesses, the issue about where to get funds from for starting up, development
and expansion can be crucial for the success of the business. It is important, therefore, that
you understand the various sources of finance open to a business and are able to assess
how appropriate these sources are in relation to the needs of the business.

There are a number of potential sources of finance to meet the needs of small and growing
businesses:

Existing shareholders and directors funds (“owner financing”);

Overdraft financing;

Trade credit;

Equity finance;

Business angel financing;

Venture capital;

Factoring and invoice discounting;

Hire purchase and leasing; and

Merchant banks (medium to longer term loans.

A key consideration in choosing the source of new business finance is to strike a balance
between equity and debt to ensure the funding structure suits the business. The main
differences between borrowed money (debt) and equity are that bankers request interest
payments and capital repayments, and the borrowed money is usually secured on business
assets or the personal assets of shareholders and/or directors. A bank also has the power to
place a business into administration or bankruptcy if it defaults on debt interest or
repayments or its prospects decline.

In contrast, equity investors take the risk of failure like other shareholders, whilst they will
benefit through participation in increasing levels of profits and on the eventual sale of their
stake. However, in most circumstances venture capitalists will also require more complex
investments (such as preference shares or loan stock) in additional to their equity stake.

The overall objective in raising finance for a company is to avoid exposing the business to
excessive high borrowings, but without unnecessarily diluting the share capital. This will
ensure that the financial risk of the company is kept at an optimal level.

=
=
- 181 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
TKMKP== c~Åíçêë=íç=ÅçåëáÇÉê=ïÜÉå=ëÉÉâáåÖ=Ñáå~åÅÉ=

When sourcing finance, management is often obligated to consider the following issues:

Duration: - for how long is the finance required?

Cost: - which source of finance is the least expensive?

Repayment: - what level is acceptable?

aìê~íáçå===

Duration depends on the reason the money is needed. No-one would take out a 25 year
mortgage to finance the purchase of a personal computer. Few people would buy a house
with a bank overdraft. Businesses apply the same principles of matching the purpose of
finance with the source of finance. This makes sense all round. For the business it ensures
that finance is guaranteed as long as it is needed. For the investor it ensures that adequate
security is available for the duration of the loan - as in the case of a 20 year loan secured
against a property that will continue to have value for all the 20 years.

`çëí=

In general, businesses look for the cheapest source of finance, even though this is not
always easy. The easiest way to compare the cost of finance is to express the annual
payment to lenders or investors as a percentage of the amount of finance provided.

Interest on a loan can be expressed in percentage terms. So can the rate of return to
shareholders.

Return on investment in shares = Dividend per share, share price change since the start
of year.

The rate of return expected by shareholders becomes the cost to the business of using
this form of finance.

oÉé~óãÉåí==

A business should not get into a position where all of its profits are being swallowed up in
interest payments. There is a real danger of borrowing too much. The same applies to
individuals. If all of the company’s profits are being used to repay loan interest, the
company runs the risk of closure because it would eventually have no working capital. It is
like an individual using up all his salary to pay his salary advances and staff loans. He would
have nothing left to finance his home operations.

- 182 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
TKMKQ== pçìêÅÉë=çÑ=Ñáå~åÅÉ=ÅçåëáÇÉê~íáçåë=

Usually companies will obtain finance from a variety of sources, including:

Internal: Owners' capital and retained profits.

External: Overdraft, leasing, hire purchase, loans, and mortgages.

fåíÉêå~ä=ëçìêÅÉë=áåÅäìÇÉW=

Retained profit - profit made is reinvested into the business.

Controlling working capital - reducing costs, delaying outflows and speeding up inflows.

Sale of assets - Assets the company owns can be sold and then leased back which frees
up a large amount of capital in the short term.

bñíÉêå~ä=ëçìêÅÉë=çÑ=Ñáå~åÅÉW=
=

Increasing trade credit - delaying payments on purchases for as long as possible.

Factoring - use a company to collect all debts.

Overdraft - an agreement with a bank to be allowed to overdraw a certain amount.

Grants - an agreed amount of money given for a special reason by government or other
organisation.

Venture capital - people invest in the company when it is unable to float on the stock
market.

Debentures - business equivalent of a mortgage. Loan for a set length of time at a set
interest rate.

Share issues - selling of new shares to raise capital.

Owners’ savings - the owners investing money into the business.

Bank loans - medium or long term loans but interest is charged.

Leasing - instead of buying.

As can be observed from above, there are quite a number of ways of raising finance for a
business. However, the type of finance chosen depends on the nature of the business.
Large organisations are able to use a wider variety of finance sources than are smaller ones.
Savings are an obvious way of putting money into a business. A small business can also
borrow from families and friends. In contrast, companies raise finance by issuing shares.
Large companies often have thousands of different shareholders.

To gain extra finance a business can take out a loan from a bank or other financial
institutions. A loan is a sum of money lent for a given period of time. Repayment is made
with interest. The lender of money needs to know all the business opportunities and risks
involved and will therefore want to see a detailed business plan. The lender may also want
some form of security should the business run into financial difficulty, and may therefore
prefer to provide a secured loan. Another way of raising short-term finance is through an
overdraft facility with a bank. The borrower is given permission to take out more from their
account than they have put in. The bank fixes a maximum limit for the overdraft. Interest is
charged on the overdraft daily.

- 183 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
Businesses may also qualify for grants. Government and private funds are sometimes made
available to businesses that meet certain conditions. For example, grants and loans may be
available to firms setting up in rural areas or where there is high unemployment.

A small business can also attract extra finance by taking on a partner or by selling shares.
The problem caused by bringing in extra people is that profits have to be shared.
A further way of raising capital that has become popular is that of venture capital. Larger
businesses with cash to spare have been putting funds into small and medium-sized
enterprises.

Once a business is up and running there are various ways of financing its expenditures.
Expensive items of equipment can be leased. Rather than buying the equipment the
business hires it from a leasing company. This saves having to lay out sums of money and
the business does not have to worry about having to carry out major repairs itself. Motor
vehicles, machines and office equipment are often leased. Hire Purchase is an alternative
way of purchasing items of equipment. With a leased item you use and pay for the item but
never own it. With hire-purchase you put down a deposit on an item and then pay off the
rest in instalments. When the last instalment has been paid you become the owner of the
item.

Another common way in which firms can finance their business in the short term is through
trade credit. In business it is common practice to purchase items and pay for them later. The
supplier will normally send the purchaser a statement at the end of each month saying how
much is owed. The buyer is then given a period of time in which to pay.

It is noteworthy, therefore, that access to finance is one of the major constraints for the
market entry and growth of small and large companies in Zambia. This chapter gives an
overview of how small and large companies finance the acquisition of equipment and raise
their capital for medium to long term use.

TKN== loafk^ov=EbnrfqvF=pe^obp=

Ordinary shares are issued to the owners of a company. They have a nominal or 'face'
value, typically of K1 or 50 ngwee. The market value of a quoted company's shares bears
no relationship to their nominal value, except that when ordinary shares are issued for cash,
the issue price must be equal to or be more than the nominal value of the shares.

Nominal Value – Ordinary shares may be issued with a nominal value, say, K1 each.
These shares will continue to be referred to as K1 shares, even though the price at
which they are bought and sold on the Lusaka Stock Exchange may differ substantially
from this. Shares without a nominal value, or shares of no par value, are quite
common in the USA but their issue in Zambia would be illegal under current
legislation. Company law in Zambia prohibits the issue of shares below their nominal
value.

Book Value – Is the sum of ordinary share capital shown in the balance sheet plus the
value of shareholders’ reserves (share premium account, revaluation reserve, retained
earnings, etc). This value may be quite different from the market value of equity
because book value reflects accounting procedures and adjustments as well as being
- 184 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
 an historical figure while market value reflects investors’ expectations and future
earnings.

Market Value – This is the value of an asset based on the amount it is believed it
would command if sold. Some assets, such as securities, are traded regularly on an
organized market and their value is relatively simple to establish. However, the market
value of, for example, specialized machinery may be more difficult to establish. The
market value of shares is simply the share price multiplied by the number of shares in
issue.

aÉÑÉêêÉÇ=çêÇáå~êó=ëÜ~êÉë==

Are a form of ordinary shares, which are entitled to a dividend only after a certain date or if
profits rise above a certain amount. Voting rights might also differ from those attached to
other ordinary shares. Ordinary shareholders put funds into their company:

By paying for a new issue of shares; and

Through retained profits.

Simply retaining profits, instead of paying them out in the form of dividends, offers an
important, simple low-cost source of finance, although this method may not provide
enough funds, for example, if the firm is seeking to grow. A new issue of shares might be
made in a variety of different circumstances:

The company might want to raise more cash. If it issues ordinary shares for cash,
should the shares be issued pro rata to existing shareholders, so that control or
ownership of the company is not affected? If, for example, a company with 200,000
ordinary shares in issue decides to issue 50,000 new shares to raise cash, should it offer
the new shares to existing shareholders, or should it sell them to new shareholders
instead?

 If a company sells the new shares to existing shareholders in proportion to

their existing shareholding in the company, we have a rights issue. In the
example above, the 50,000 shares would be issued as a one-in-four rights
issue, by offering shareholders one new share for every four shares they
currently hold.
 If the number of new shares being issued is small compared to the number
of shares already in issue, it might be decided instead to sell them to new
shareholders, since ownership of the company would only be minimally
affected.

The company might want to issue shares partly to raise cash, but more importantly to
float' its shares on a stick exchange.

The company might issue new shares to the shareholders of another company, in order
to take it over.

- 185 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
kÉï=ëÜ~êÉë=áëëìÉë==

A company seeking to obtain additional equity funds may be:

An unquoted company wishing to obtain a Stock Exchange quotation;

An unquoted company wishing to issue new shares, but without obtaining a Stock
Exchange quotation; and

A company which is already listed on the Lusaka Stock Exchange wishing to issue
additional new shares.

The methods by which an unquoted company can obtain a quotation on the stock market
are:

An offer for sale;

A prospectus issue;

A placing; and

An introduction.

lÑÑÉêë=Ñçê=ë~äÉW==

An offer for sale is a means of selling the shares of a company to the public.

An unquoted company may issue shares, and then sell them on the Lusaka Stock
Exchange, to raise cash for the company. All the shares in the company, not just the
new ones, would then become marketable.

Shareholders in an unquoted company may sell some of their existing shares to the
general public. When this occurs, the company is not raising any new funds, but just
providing a wider market for its existing shares (all of which would become
marketable), and giving existing shareholders the chance to cash in some or all of their
investment in their company.

When companies 'go public' for the first time, a 'large' issue will probably take the form of
an offer for sale. A smaller issue is more likely to be a placing, since the amount to be raised
can be obtained more cheaply if the issuing house or other sponsoring firm approaches
selected institutional investors privately.

j~êâÉí=mêáÅÉ=éÉê=pÜ~êÉ=

The Market price per share (“MPS”) is the ex-dividend market price. Ex-dividend means that
in buying a share today, the investor will not participate in the forthcoming dividend
payment. Sometimes, the market price may be quoted cum-dividend which means with
dividend rights attached. Here, the investor will participate in the forthcoming dividend
payment. Quite naturally, the investor would be willing to pay a higher price for the shares
quoted cum-dividend knowing that he would be taking part in the forthcoming dividend
payment.

- 186 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
The relationship between cum-dividend price and the ex-dividend price may be expressed as
follows:

MPS (ex-dividend) = MPS (cum-dividend) – forthcoming dividend per share.

b~êåáåÖë=éÉê=ëÜ~êÉ=

Earnings per share (“EPS”) is a company’s net profit attributable to ordinary shareholders
divided by the number of ordinary shares in issue.

Example

K’million

Earnings before interest and tax 525

Interest on debt 75

Earnings after debt interest 450

Tax payable 125

Earnings after tax available for distribution 325

Number of shares in issue = 175,000,000

EPS = 325 / 175 = 186 ngwee per share

An important point to remember is that EPS is an historical figure and can be manipulated
by changes in accounting policies, mergers or acquisitions.

mêáÅÉ=b~êåáåÖë=o~íáç=

A common benchmark when analyzing different companies is the use of the price/earnings
ratio which expresses in a single figure the relationship between the market price of a
company’s shares and the earnings per share. The PE ratio is calculated as Market price per
share/ Earnings per share.

Using the figures from the EPS calculation example above, and assuming that the
company’s current share price is 2,250 ngwee, the PE Ratio would be 2,250/186 = 12.

- 187 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
The PE Ratio is often referred to as the market capitalization rate. This simply means that
the market value of the company’s equity can be calculated by multiplying last year’s
earnings per share by the PE Ratio (to give the share price), then multiplying by the number
of shares in issue.

b~êåáåÖë=váÉäÇ=

The Earnings Yield is the reciprocal (a number or quantity divided into 1) of the PE Ration.
Again, using the EPS example above, the earnings yield is 8.3% or 0.083 (186/2,250). The
PE ratio is therefore the reciprocal of this = 1/0.083 = 12.

The market price will incorporate expectations of all buyers and sellers of the company’s
shares and so this is an indication of the future earning power of the company.

Earnings Yield = EPS/ MPS

aáîáÇÉåÇ=m~ó=çìí=o~íÉ=

The cash effect of payment of dividend is measured by the dividend payout rate.

Pay out rate = dividend per share/ earnings per share = DPS/EPS

Assuming the cash dividend is 20 ngwee per ordinary share out of EPS of 40 ngwee, then
the dividend payout rate is 20/40 = 0.5 or 50%. Usually, a company with a high PE Ratio
has a low dividend payout ratio as the high growth company needs to retain more
resources in the business. A more stable business would have a relatively low PE ratio and
higher dividend payout ratio.

aáîáÇÉåÇ=váÉäÇ=

Dividend yield will indicate the return on capital investment, relative to market price.

Dividend yield = dividend per share/ market price per share = DPS/MPS

Assuming a dividend of 25 ngwee per each ordinary share and a market price of 250
ngwee per share, then dividend yield is 25/250 = 0.1 or 10%. Buying a share today for 250
ngwee should give the investor a return of 10% for the year, based on the dividend
income.

aáîáÇÉåÇ=`çîÉê=

Dividend cover measures the ability of the company to maintain existing level of dividend
and is used in conjunction with the dividend yield.

Dividend Cover = Earnings per share / Dividend per share

- 188 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
Assuming EPS of 50 ngwee and a net dividend of 20 ngwee then dividend cover is 50/20 =
2.5 times. The higher the dividends cover, the more likely it is that the dividend yield can be
maintained. Dividend cover also gives an indication of the level of profits being retained by
the company for investment by considering how many times this year’s dividend is covered
by this year’s earnings.

oáÖÜíë=fëëìÉë==

A rights issue provides a way of raising new share capital by means of an offer to existing
shareholders, inviting them to subscribe cash for new shares in proportion to their existing
holdings. For example, a rights issue on a one-for-four basis at 280n per share would mean
that a company is inviting its existing shareholders to subscribe for one new share for every
four shares they hold, at a price of 280n per new share.

A company making a rights issue must set a price which is low enough to secure the
acceptance of shareholders, who are being asked to provide extra funds, but not too low,
so as to avoid excessive dilution of the earnings per share.

aÉÅáÇáåÖ=íÜÉ=áëëìÉ=éêáÅÉ=Ñçê=~=êáÖÜíë=áëëìÉ=

In theory there is no upper limit to an issue price but in practice it would never be set higher
than the prevailing MPS of the shares, otherwise shareholders will not be prepared to buy
as they could have purchased more shares at the existing market price anyway. Indeed the
issue price is normally set at a discount to MPS. This discount is usually in the region of
20%. In theory, there is no lower limit to an issue price but in practice it can never be lower
than the nominal value of the shares. Subject to these practical limitations, any price may
be selected within these values.

aÉÅáÇáåÖ=íÜÉ=áëëìÉ=èì~åíáíó=Ñçê=~=êáÖÜíë=áëëìÉ=

It is normal for the issue price to be selected first and then the quantity of shares to be
issued becomes a passive decision. The effect of the additional shares on earnings per
share, dividend per share and dividend cover should also be considered. The selected
additional issue quantity will then be related to the existing share quantity for the issue
terms to be calculated. The proportion is normally stated in its simplest form eg. 1 for 4,
meaning that shareholders may subscribe to purchase one new share for every four shares
they currently hold.

qÉêãë=çÑ=~å=áëëìÉ=

Once the issue price and share quantity have been selected by the company, the terms of
the rights issue can then be announced. For example, Ngosa Chirwa Plc has 2 million K1
ordinary shares in issue with a current MPS of K5. It decides to raise K2 million by means of
a rights issue at K4 per share. Since 500,000 additional shares will now have to be issued,
the terms of the rights issue may be summarised as 1 for 4 at K4.

- 189 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
qÜÉ=qÜÉçêÉíáÅ~ä=ÉñJêáÖÜíë=éêáÅÉ=EqbomF=

After the announcement of a rights issue, there is tendency for share prices to fall.
Although the extent and duration of the fall may depend on the number of shareholders
and the seize of their holdings. This temporary fall is due to uncertainty in the market about
the consequences of the issue, with respect to future profits, earnings and dividends.

After the issue has actually been made, the market price per share will normally fall,
because there are more shares in issue and the new shares were in fact issued at a
discount.

When a rights issue is announced, all existing shareholders have the right to subscribe for
new shares, and so there are rights attached to the existing shares. The shares are therefore
described as being “cum rights” (with rights attached) and are traded cum rights. On the
first day of dealing in the newly issued shares, the rights no longer exist and the old shares
are now “ex-rights” (without rights attached).

Assuming this rights issue is taken up by existing shareholders, the market price of the
shares will readjust to a value above that of the rights issue but below the original market
price. Using the data above for Ngosa Chirwa Plc, the following TERP calculation results:

Ngwee

1 New share at 400n 400

4 Old shares at 500n 2,000

5 2,400

TERP = 2,400/5 = 480 n

This calculation may also be expressed by way of a formula as follows:

TERP = [Pp No/ N] + [Pn Nn/ N] where:

Pp = pre-issue price

Pn = New issue price

No = Number of old shares

Nn = Number of new shares

N = Total Number of shares

- 190 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
Therefore:

TERP = [500n * 2,000,000/ 2,500,000] + [400n *500,000/ 2,500,000]

= 400n + 80n

= 480 n

aÉí~áäÉÇ=bñ~ãéäÉ=Ó=`ÜáÑï~å~âÉåá=gìåáçê=

Chifwanakeni Junior Plc has a paid –up ordinary share capital of K2, 000,000 represented
by 4 million shares of 50n each. Earnings after tax in the most recent year were K750, 000
of which K250, 000 was distributed as dividend. The current price/earnings ratio of these
shares, as reported by the Business Post is 8.

The company is planning a major investment that will cost K2, 025,000 and is expected to
produce additional after tax earnings over the foreseeable future at the rate of 15% on the
amount invested.

The necessary finance is to be raised by a rights issue to the existing shareholders at a price
of 25% below the current market price of the company’s shares.

a) You are required to calculate:

(i) The current market price of the shares already in issue

(ii) The price at which the rights issue will be made
(iii) The number of new shares that will be issued
(iv) The price at which the shares of the company should theoretically be quoted on
completion of the rights issue (i.e. the ex-rights price), ignoring incidental costs
and assuming that the market accepts the company’s forecast of incremental
earnings.

b) It has been said that, provided the required amount of money is raised and that the
market is made aware of the earnings power of the new investment, the financial position
of existing shareholders should be the same whether or not they decide to subscribe for the
rights they are offered.

You are required to illustrate and comment on this statement.

Solution

a) Calculation:

i) Current market price of shares already in issue:

Earnings per share = K750, 000/ 4,000,000

= 18.75n

- 191 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
P/E Ratio = Market price per share/ Earnings per share
= 8 X 18.75n
= K1.50

ii) Price at which rights issue will be made:

K1.50 X 75% (i.e 25% below current market price) = K1.125

iii) Number of new shares that will be issued:

K2,025,000/ K1.125 = 1.8 million shares

iv) Ex- rights price is:

{1.50 X 4,000,000} + {1.125 X 1,800,000 X 15%}

5,800,000 5,800,000 12.5%

= K1.034 + K0.419
=K1.453

* The price/earnings ratio is given as 8. This would imply an earnings yield of (1/8) = 12.5%.
This is assumed to be the yield or rate of return on existing funds.

b) This statement can be illustrated as follows:

For every 20 shares held the rights issue means another nine shares. At least in theory, the
selling price of the right to purchase one share will be K1.453 less K1.125 = K0.328.

A shareholder with 20 shares taking up the rights:

K
Market value of 29 shares at K1.453 each 42.137
Less: Cost of taking up 9 new shares at K1.125 10.125
----------
32.012
=====

- 192 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
A shareholder with 20 shares selling the rights:
K
Market value of 20 shares after rights issue at K1.453 29.060
Add: Sale of 9 rights at K0.328 2.952
---------
32.012
=====

* The above, however, assumes no transaction costs. Furthermore, the market may read a
particular message into the rights issue which could affect the above calculations.

TKO= mobcbobk`b=pe^obp==

Preference shares have a fixed percentage dividend before any dividend is paid to the
ordinary shareholders. As with ordinary shares a preference dividend can only be paid if
sufficient distributable profits are available, although with 'cumulative' preference shares
the right to an unpaid dividend is carried forward to later years. The arrears of dividend on
cumulative preference shares must be paid before any dividend is paid to the ordinary
shareholders.

From the company's point of view, preference shares are advantageous in that:

Dividends do not have to be paid in a year in which profits are poor, while this is not
the case with interest payments on long term debt (loans or debentures);

Since they do not carry voting rights, preference shares avoid diluting the control of
existing shareholders while an issue of equity shares would not;

Unless they are redeemable, issuing preference shares will lower the company's
gearing. Redeemable preference shares are normally treated as debt when gearing is
calculated;

The issue of preference shares does not restrict the company's borrowing power, at
least in the sense that preference share capital is not secured against assets in the
business; and

The non-payment of dividend does not give the preference shareholders the right to
appoint a receiver, a right which is normally given to debenture holders.

However, dividend payments on preference shares are not tax deductible in the way that
interest payments on debt are. Furthermore, for preference shares to be attractive to
investors, the level of payment needs to be higher than for interest on debt to compensate
for the additional risks.

For the investor, preference shares are less attractive than loan stock because:

They cannot be secured on the company's assets; and

The dividend yield traditionally offered on preference dividends has been much too low
to provide an attractive investment compared with the interest yields on loan stock in
view of the additional risk involved.

- 193 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
TKP== ab_q=cfk^k`b=

Debt finance is more attractive than equity finance, not only because the costs of raising
the funds (for example arrangement fees with a bank or issue costs of a bond) are lower,
but because the annual return required to attract investors is less than for equity.

This is because investors recognize that investing in a firm via debt finance is less risky than
investing via shares. It is less risky because interest is paid out before dividends are paid so
there is greater certainty of receiving a return than there would be for equity holders. Also,
if the firm goes into liquidation, the holders of a debt type of financial security are paid
before shareholders receive anything. Offsetting these plus-points for debt are the facts
that lenders do not, generally, share in the value created by an extraordinarily successful
business and there is an absence of voting power – although debt holders are able to
protect their position to some extent through rigorous lending agreements.

When a company pays interest the Zambia Revenue Authority regards this as a cost of
doing business and therefore it can be used to reduce the taxable profit. This lowers the
effective cost to the firm of servicing the debt compared with servicing equity capital
through dividends which are not tax deductible. Thus to the attractions of the low required
return on debt we must add the benefit of tax deductibility.

There are dangers associated with raising funds through debt instruments. Creditors are
often able to claim some or all of the assets of the firm in the event of non-compliance with
the terms of the loan. This may result in liquidation. Institutions which provide debt finance
often try to minimize the risk of not receiving interest and their original capital. They do this
by first of all looking to the earning ability of the firm, that is, the pre-interest profits in the
years over the period of the loan.

iç~å=píçÅâ=

Loan stock is long-term debt capital raised by a company for which interest is paid, usually
half yearly and at a fixed rate. Holders of loan stock are therefore long-term creditors of the
company. Loan stock has a nominal value, which is the debt owed by the company, and
interest is paid at a stated "coupon yield" on this amount. For example, if a company issues
10% loan stocky the coupon yield will be 10% of the nominal value of the stock, so that
K100 of stock will receive K10 interest each year. The rate quoted is the gross rate, before
tax.

Debentures are a form of loan stock, legally defined as the written acknowledgement of a
debt incurred by a company, normally containing provisions about the payment of interest
and the eventual repayment of capital.

aÉÄÉåíìêÉë=ïáíÜ=~=Ñäç~íáåÖ=ê~íÉ=çÑ=áåíÉêÉëí==

These are debentures for which the coupon rate of interest can be changed by the issuer, in
accordance with changes in market rates of interest. They may be attractive to both lenders
and borrowers when interest rates are volatile.

- 194 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
pÉÅìêáíó==

Loan stock and debentures will often be secured. Security may take the form of either a
fixed charge or a floating charge.

Fixed charge; Security would be related to a specific asset or group of assets, typically
land and buildings. The company would be unable to dispose of the asset without
providing a substitute asset for security, or without the lender's consent; and

Floating charge; With a floating charge on certain assets of the company (for
example, stocks and debtors), the lender's security in the event of a default payment is
whatever assets of the appropriate class the company then owns (provided that
another lender does not have a prior charge on the assets). The company would be
able, however, to dispose of its assets as it chose until a default took place. In the
event of a default, the lender would probably appoint a receiver to run the company
rather than lay claim to a particular asset.

qÜÉ=êÉÇÉãéíáçå=çÑ=äç~å=ëíçÅâ==

Loan stock and debentures are usually redeemable. They are issued for a term of ten years
or more, and perhaps 25 to 30 years. At the end of this period, they will "mature" and
become redeemable (at par or possibly at a value above par).

Most redeemable stocks have an earliest and latest redemption date. For example, 18%
Debenture Stock 2007/09 is redeemable, at any time between the earliest specified date (in
2007) and the latest date (in 2009). The issuing company can choose the date. The decision
by a company when to redeem a debt will depend on:

How much cash is available to the company to repay the debt; and

The nominal rate of interest on the debt. If the debentures pay 18% nominal interest
and the current rate of interest is lower, say 10%, the company may try to raise a new
loan at 10% to redeem the debt which costs 18%. On the other hand, if current
interest rates are 20%, the company is unlikely to redeem the debt until the latest date
possible, because the debentures would be a cheap source of funds.

There is no guarantee that a company will be able to raise a new loan to pay off a maturing
debt, and one item to look for in a company's balance sheet is the redemption date of
current loans, to establish how much new finance is likely to be needed by the company,
and when.

Mortgages are a specific type of secured loan. Companies place the title deeds of freehold
or long leasehold property as security with an insurance company or mortgage broker and
receive cash on loan, usually repayable over a specified period. Most organisations owning
property which is unencumbered by any charge should be able to obtain a mortgage up to
two thirds of the value of the property.

As far as companies are concerned, debt capital is a potentially attractive source of finance
because interest charges reduce the profits chargeable to company tax in Zambia.

- 195 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
TKQ== obq^fkba=b^okfkdp=

For any company, the amount of earnings retained within the business has a direct impact
on the amount of dividends. Profit re-invested as retained earnings is profit that could have
been paid as a dividend. The major reasons for using retained earnings to finance new
investments, rather than to pay higher dividends and then raise new equity for the new
investments, are as follows:

The management of many companies believes that retained earnings are funds which
do not cost anything, although this is not true. However, it is true that the use of
retained earnings as a source of funds does not lead to a payment of cash;

The dividend policy of the company is in practice determined by the directors. From
their standpoint, retained earnings are an attractive source of finance because
investment projects can be undertaken without involving either the shareholders or any
outsiders;

The use of retained earnings as opposed to new shares or debentures avoids issue
costs; and

The use of retained earnings avoids the possibility of a change in control resulting from
an issue of new shares.

Another factor that may be of importance is the financial and taxation position of the
company's shareholders. If, for example, because of taxation considerations, they would
rather make a capital profit (which will only be taxed when shares are sold) than receive
current income, then finance through retained earnings would be preferred to other
methods.

A company must restrict its self-financing through retained profits because shareholders
should be paid a reasonable dividend, in line with realistic expectations, even if the directors
would rather keep the funds for re-investing. At the same time, a company that is looking
for extra funds will not be expected by investors (such as banks) to pay generous dividends,
nor over-generous salaries to owner-directors.

TKR=ib^pfkd=cfk^k`b=

One of the possibilities for businesses to finance their equipment is to look for a leasing
arrangement. Leasing is a common way for small and medium sized enterprises around the
world to finance vehicles, machinery and equipment. In developed countries up to a third of
private investment is financed through leasing. Over the last decade the leasing industry in
developing countries has seen a spectacular growth, with even micro-finance institutions
becoming interested in the concept.

Financial leasing is a contractual arrangement that allows one party (the lessee) to use an
asset owned by the leasing company (the lessor) in exchange for specified periodic
payments. During the lease period legal ownership of the asset is retained by the lessor.
Most leasing contracts will include the option for the lessee to purchase the asset at the
end of the lease term for a nominal price.

- 196 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
The great advantage of lease finance for businesses is the absence of collateral
requirements. The equipment itself will serve as security for the transaction since the
ownership of the asset is retained by the leasing company. In case the business is unable to
make the periodic payments the leasing company can simply repossess the asset. A leasing
arrangement can be concluded quicker and simpler than a bank loan. Rather than looking
into the credit history and the asset structure of the client, leasing companies will focus on
the clients' ability to generate sufficient cash through the investment financed in the leasing
arrangement.

The down payment in a lease arrangement is often low and the percentage of capital cost
of the equipment financed high. Whereas banks often require clients to finance up to 40%
of the investment from their own funds, the up-front payment in a typical lease
arrangement accounts for only 10% of the total cost. This enables businesses to keep their
resources as working capital for the payment of salaries and construction materials.

Therefore, leasing enables a business to acquire the use of assets such as plant and
machinery without having to pay large sums of money for ownership of the equipment,
initially. Instead a business simply leases the equipment from a leasing company who retain
ownership. There are two main forms of lease in the Zambia, an Operating Lease, in
which the company pays for use of the equipment for a set period of time after which it is
returned to the leasing company, or a Finance Lease, where at the end of the lease period
there is the option to purchase the equipment outright for a further nominal amount.
Whilst leasing does not inject money directly into the business, and in the long term usually
costs more than buying the equipment outright, in cash flow terms it’s an effective
method of a business getting the equipment it needs when its cash flow is tight.

qóéÉë=çÑ=äÉ~ëáåÖ=

Four different types of leasing can be distinguished

cáå~åÅÉ=äÉ~ëÉë=

Finance leasing is an alternative to bank loan financing for equipment purchases. The lessor
buys the equipment chosen by the client, who then uses it for a significant period of its
useful life. Financial leases are also called full-payout leases because payments during the
lease term amortize the lessors' total purchase costs (residual value is typically between 0%
- 5% of original acquisition price), cover his interest costs and provide him profit. The lessee
carries the risk of obsolescence, the costs of maintaining the asset and insurance. The lessee
typically has the right to purchase the asset at the end of the lease contract for a nominal
fee often known as pepper corn rent.

eáêÉJéìêÅÜ~ëÉ=

Hire Purchase is a hybrid instrument also providing an alternative to bank financing for the
purchase of equipment. The instrument is typically used for retail or individual financing of
motorcycles, sewing machines, refrigerators, and other small items. The lessee pays a higher
down payment (sometimes up to 30% of the purchase price) and, with each lease payment
an increasingly higher percentage of ownership is transferred to the lessee, thus building up
- 197 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
equity. Ownership transfer is automatic once all required payments are made. Compared to
a financial lease, this arrangement is judicially less secure for the lessor because the lessee is
part owner of the asset. On the other hand, lessees have a sufficiently large stake in the
equipment being acquired to avoid the risk of losing that stake through default.

Hire purchase is a form of instalment credit. Hire purchase is similar to leasing, with the
exception that ownership of the goods passes to the hire purchase customer on payment of
the final credit instalment, whereas a lessee never becomes the owner of the goods.

Hire purchase agreements usually involve a finance house:

The supplier sells the goods to the finance house.

The supplier delivers the goods to the customer who will eventually purchase them.

The hire purchase arrangement exists between the finance house and the customer.

The finance house will always insist that the hirer should pay a deposit towards the
purchase price. The size of the deposit will depend on the finance company's policy and its
assessment of the hirer. This is in contrast to a finance lease, where the lessee might not be
required to make any large initial payment.

An industrial or commercial business can use hire purchase as a source of finance. With
industrial hire purchase, a business customer obtains hire purchase finance from a finance
house in order to purchase the fixed asset. Goods bought by businesses on hire purchase
include company vehicles, plant and machinery, office equipment and farming machinery.

léÉê~íáåÖ=äÉ~ëÉë=

An operating lease is not a means to finance equipment purchase. The lessee signs a
contract with a leasing company for short-term use of a piece of equipment the leasing
company has on hand, e.g. car rentals. The lessor recovers the capital cost of the
equipment from multiple, serial rentals and the final sale of the asset. Maintenance costs
and risks of obsolescence are borne by the leasing company.

^=ë~äÉ=~åÇ=äÉ~ëÉJÄ~Åâ==

A sale and lease back arrangement is like a financial lease, with the difference that the
client initially owns the piece of equipment. The client sells the equipment to the lessor, in
order to acquire funds for working capital. At the same time the client signs a lease
contract to lease back the equipment through regular lease payments.

qÜÉ=äÉ~ëÉ=~êê~åÖÉãÉåí=

In a standard financial lease the lessee - in this case the small contractor - selects the
equipment and negotiates the main purchase terms with the supplier. In case the lessor
selects the equipment a fee can be charged for this service. While the asset itself serves as
collateral under a lease arrangement, some leasing companies will ask for additional
collateral in the form of marketable securities, trade receivables or third party guarantees.

- 198 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
Most lease contracts will contain a clause requiring the lessee to provide the lessor with
certified financial statements during the period of the lease.

Leasing rates are often slightly higher than bank interest rates. On top of the leasing rates
the lessor will charge the client a nominal fee for the administrative costs related to the
lease arrangement. The lessee is usually responsible for the costs of maintenance, servicing
and repairs of the equipment. In most cases the lessee is obliged to insure the equipment.
Leasing arrangements still remain attractive as the up-front down payments are low and as
contracts can be structured to match the cash flow generation of the contractors business.

Leasing companies offer different options for the client at the end of the lease term:

The equipment can be purchased at residual value. The residual value is estimated at
the beginning of the lease term, based on the likely market value at the end of the
period.

The client can renew the lease at a significantly reduced rental. Rentals during a
secondary period are lower than in the primary period, usually about 5% of the original
capital expenditure as a total annual secondary rental.

The client receives a share in the profits of the equipment sale. At the end of the lease,
the equipment will be sold to a third party and the client will be allowed to share in the
benefit of the sale proceeds according to a distribution of proceeds defined in the lease
contract.

The end-of-lease option is an important part of the lease contract. A pre-set purchase price
stated in the contract enables the contractor to foresee how much funds he needs for the
final purchase. Contractors who have the intention to buy the asset at the end of the lease
term have an incentive to maintain the equipment properly.

q~ñ=áåÅÉåíáîÉë=

Tax incentives lie at the basis of the rapid expansion of the leasing sector in industrialised
countries. In order to facilitate entrepreneurs' access to finance for productive equipment,
many countries have embraced a tax system that is conducive for both lessor and lessee.
The lessor, treated as the owner of the equipment, registers the full lease payment
(principal and interest) as income but takes the depreciation of the asset, usually on an
accelerated schedule. The lessee claims the lease payment as deduction from taxable
income. Since the lease term is usually shorter than the economic life of the equipment, the
lessee in fact "depreciates" the equipment more rapidly than it would in case of purchase
of the equipment. Since both parties accelerate depreciation of the asset, total tax
payments are decreased, to the benefit of the leasing industry.

While similar tax incentives might exist in developing countries, they are not the main
reason for the expansion of leasing companies in Africa and Asia. The advantages of
accelerated depreciation are less relevant when small and medium sized enterprises are able
to avoid paying income tax. Simpler security arrangements and low down payments are
more likely explanations for the growing importance of leasing in Zambia.

- 199 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
tÜó=ãáÖÜí=äÉ~ëáåÖ=ÄÉ=éçéìä~ê\=

The attractions of leases to the supplier of the equipment, the lessee and the lessor are as
follows:

The supplier of the equipment is paid in full at the beginning. The equipment is sold to
the lessor, and apart from obligations under guarantees or warranties, the supplier has
no further financial concern about the asset.

The lessor invests finance by purchasing assets from suppliers and makes a return out
of the lease payments from the lessee. Provided that a lessor can find lessees willing to
pay the amounts he wants to make his return, the lessor can make good profits. He
will also get capital allowances on his purchase of the equipment.

Leasing might be attractive to the lessee:

if the lessee does not have enough cash to pay for the asset, and would have difficulty
obtaining a bank loan to buy it, and so has to rent it in one way or another if he is to
have the use of it at all; or

if finance leasing is cheaper than a bank loan. The cost of payments under a loan
might exceed the cost of a lease.

Operating leases have further advantages:

The leased equipment does not need to be shown in the lessee's published balance
sheet, and so the lessee's balance sheet shows no increase in its gearing ratio.

The equipment is leased for a shorter period than its expected useful life. In the case of
high-technology equipment, if the equipment becomes out-of-date before the end of
its expected life, the lessee does not have to keep on using it, and it is the lessor who
must bear the risk of having to sell obsolete equipment secondhand.

The lessee will be able to deduct the lease payments in computing his taxable profits.

iÉ~ëáåÖ=J=íÜÉ=äÉÖ~ä=~åÇ=êÉÖìä~íçêó=ÉåîáêçåãÉåí=

An enabling legal and regulatory framework is necessary for the leasing industry to offer a
competitive alternative to bank finance. The rights and duties of both lessor and lessee have
to be clearly stated in the legal framework, providing lessors with straightforward
procedures to repossess leased assets in case of default. A certain degree of regulation in
terms of prudential conditions imposed by the Bank of Zambia for operation is generally
considered beneficial for the development of the leasing sector.

Leasing companies do not take deposits from the general public and are therefore less
stringently regulated than other financial institutions. How easy or difficult it is for a micro-
finance institution to start a leasing scheme depends on the leasing law in the country. In
some countries deposit-taking micro-finance institutions could be required to set up a
subsidiary to do the leasing.

- 200 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
The table below gives some characteristics of a leasing-friendly regulatory environment.

`Ü~ê~ÅíÉêáëíáÅë=çÑ=~=êÉÖìä~íçêó=ÉåîáêçåãÉåí=ÑêáÉåÇäó=íç=äÉ~ëáåÖ=

Banking regulations Actions to promote leasing industry

Licencing · Recognise existence of leasing

Prudential requirements · Restrict leasing to licensed institutions and require banks to set up separate
subsidiaries to do leasing

· Permit leasing companies to mobilise only term deposits

· Minimum capital requirements may be lower than for many other financial
institutions

· Other prudential requirements may be less strict than those for traditional
deposit-taking institutions
Legal framework
Lessor's ownership · Clearly stated with simple, effective and timely procedures for repossession if
lessee defaults
Lessee's rights
· Clearly stated uninterrupted use of leased asset for the lease period if lease
Central registry rental payments are current

· Registry system and procedures for debt obligations and security rights,
especially movable property
Tax treatment
Lessor · Allowed to depreciate assets; lease payment taxed as income; asset
depreciated over a time period shorter than or equal to lease contract
Lessee
· Lease payments treated as deductible expense for tax purposes
Sales tax
· Post-contract sale of leased asset exempt from sales tax
Capital allowances
· Given to lessor or lessee; equal treatment compared to other financing
Foreign investment regime
Convertibility of leasing · Free convertibility to foreign currency-denominated deposit account
company’s paid-in capital
· Comparable to other financial institutions
Corporate tax treatment
· Free transferability and remittance; possible exemption from withholding tax
Dividends and royalties
· Should receive same customs and tax treatment as if imports were
Capital equipment imports (for undertaken directly by end-users
on-leasing)

- 201 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
TKS===dlsbokjbkq=^ppfpq^k`b=

The government provides finance to companies in cash grants and other forms of direct
assistance, as part of its policy of helping to develop the national economy, especially in
high technology industries and in areas of high unemployment.

TKT===sbkqrob=`^mfq^i=

Venture capital is money put into an enterprise which may all be lost if the enterprise fails.
A businessman starting up a new business will invest venture capital of his own, but he will
probably need extra funding from a source other than his own pocket. However, the term
'venture capital' is more specifically associated with putting money, usually in return for an
equity stake, into a new business, a management buy-out or a major expansion scheme.

The institution that puts in the money recognises the gamble inherent in the funding. There
is a serious risk of losing the entire investment, and it might take a long time before any
profits and returns materialise. But there is also the prospect of very high profits and a
substantial return on the investment. A venture capitalist will require a high expected rate
of return on investments, to compensate for the high risk.

A venture capital organisation will not want to retain its investment in a business
indefinitely, and when it considers putting money into a business venture, it will also
consider its "exit", that is, how it will be able to pull out of the business eventually (after
five to seven years, say) and realise its profits.

When a company's directors look for help from a venture capital institution, they must
recognise that:

The institution will want an equity stake in the company;

It will need convincing that the company can be successful ; and

It may want to have a representative appointed to the company's board, to look after
its interests.

The directors of the company must then contact venture capital organisations, to try and
find one or more which would be willing to offer finance. A venture capital organisation
will only give funds to a company that it believes can succeed, and before it will make any
definite offer, it will want from the company management:

A business plan;

Details of how much finance is needed and how it will be used;

The most recent trading figures of the company, a balance sheet, a cash flow forecast
and a profit forecast;

Details of the management team, with evidence of a wide range of management skills

Details of major shareholders;

Details of the company's current banking arrangements and any other sources of
finance; and

Any sales literature or publicity material that the company has issued.

- 202 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
A high percentage of requests for venture capital are rejected on an initial screening, and
only a small percentage of all requests survive both this screening and further investigation
and result in actual investments.

TKU=co^k`efpfkd=

Franchising is a method of expanding business on less capital than would otherwise be

needed. For suitable businesses, it is an alternative to raising extra capital for growth.
Franchisors include Wimpy, Nando's Chicken and Chicken Inn.

Under a franchising arrangement, a franchisee pays a franchisor for the right to operate a
local business, under the franchisor's trade name. The franchisor must bear certain costs
(possibly for architect's work, establishment costs, legal costs, marketing costs and the cost
of other support services) and will charge the franchisee an initial franchise fee to cover set-
up costs, relying on the subsequent regular payments by the franchisee for an operating
profit. These regular payments will usually be a percentage of the franchisee's turnover.

Although the franchisor will probably pay a large part of the initial investment cost of a
franchisee's outlet, the franchisee will be expected to contribute a share of the investment
himself. The franchisor may well help the franchisee to obtain loan capital to provide his-
share of the investment cost.

The advantages of franchises to the franchisor are as follows:

The capital outlay needed to expand the business is reduced substantially; and

The image of the business is improved because the franchisees will be motivated to
achieve good results and will have the authority to take whatever action they think fit to
improve the results.

The advantage of a franchise to a franchisee is that he obtains ownership of a business for

an agreed number of years (including stock and premises, although premises might be
leased from the franchisor) together with the backing of a large organisation's marketing
effort and experience. The franchisee is able to avoid some of the mistakes of many small
businesses, because the franchisor has already learned from its own past mistakes and
developed a scheme that works.

- 203 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
TKV== bu^jfk^qflk=qvmb=nrbpqflk=

Pleasure boat operators Limited are considering investing in a new boat for their fleet. The
company can either borrow the necessary funds from its bank at 9% and purchase the
boat, or enter into a finance lease involving five annual year end payments of K24, 000,000
The new boat costs K100, 000, 000 and would attract capital allowances at 20% on
straight line basis over its five year life for its owners. Company tax is 35% payable in the
year of the relevant profits.

Required:

You are required to calculate which of the two options, borrowing or leasing, is financially
more advantageous for the company.

plirqflk=

The first stage is to calculate the capital allowances attracted by the purchase of the boat.
The first capital allowance is assumed to be claimed at the end of year 1.

Year Allowance Tax Shield (35%)

1 (K100, 000* 0.20 20,000 7,000

2 20,000 7,000
3 20,000 7,000
4 20,000 7,000
5 20,000 7,000
-------- ---------
100,000 35,000
====== ======

After Tax Cash Flows

(9% * (1-0.35) = 5.85%, say 6%.

Year Investment Tax Shield DF 6% PV

0 (100,000) 0 1.00 (100,000)

1 7,000 0.943 6,601
2 7,000 0.890 6,230
3 7,000 0.840 5,880
4 7,000 0.792 5,544
5 7,000 0.747 5,229
-----------
NPV = (70,516)
======

- 204 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=
Finance Lease

Under Zambian legislation depreciation on leased assets is treated as a tax deductible

expense, as is the interest element of the finance lease payments;

For exam purposes, assume that it is the full finance lease payment that is allowable for
tax;

The after tax cash flows associated with this option should again be discounted at the
after tax cost of borrowing.

Year Lease payment Tax shield Net Cash DF 6% PV

1 (24,000) 8,400 (15,600) 0.943 (14,711)

2 (24,000) 8,400 (15,600) 0.890 (13,884)
3 (24,000) 8,400 (15,600) 0.840 (13,104)
4 (24,000) 8,400 (15,600) 0.792 (12,355)
5 (24,000) 8,400 (15,600) 0.747 (11,653)
------------
(65,707)
=======

Conclusion:

The finance lease is financially the most advantageous method of financing the investment
in the boat because its gives a lower negative NPV.

**********************************************************************

- 205 -

`Ü~éíÉê=T=
pçìêÅÉë=çÑ=`~éáí~ä=Ó=m~êí=f=