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The lease offer is as follows:
The lease will be over 5 years with lease payments of $146,000 annually in advance (at the
start of each accounting period). Tax is payable 1 year after the accounting year-end and
the corporation tax rate is 25%. Maintenance is payable by the lessor and costs $20,000
per annum payable at the end of each year, including the last year in preparation for sale.
The residual value is expected to be $40,000 (the expected tax written down value at the
end of the lease) and the lessor will retain that.
What is the present value of the maintenance cash flows, after tax?
Answer is (65433)
They have considered tax relief as $20,000 × 25% × 4.212 × 0.893 = $18,807 whereas i have calcuated it as 20000*0.25*(4.917-0.943) = 19870
Where did i go wrong?
ThanksYou have not given the rate of interest and so I cannot check your workings 🙂
Brash Co can buy a new piece of sophisticated machinery for $500,000 by borrowing under
a secured loan at 8%. Tax is at 25%. So after tax cost i have taken as 6%It seems that they have made an error.
The flows are from time 2 to time 6, and so you can either do as you have done (the 6 year annuity factor less the 1 year factor), or alternatively take the 5 year annuity factor (because there are 5 years of flows) and multiply by the 1 year factor (because the annuity starts in 2 years rather than in 1 year).
It seems that they have been taking the second approach but used the wrong 1 year discount factor.
(The two approaches will give slightly different answers, but this is due to the rounding in the tables, which is irrelevant in the exam.)
cheryl78:
It is the cost of debt (8% – (25% x 8%))
Have you watched my free lectures on the cost of capital?
Hello John,
Hope you are doing well.
Just wanted to thank you a lot for the explanation I was looking for, much appreciated!!
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