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a lease versus buy evaluation has been performed. management accountant performed calculation by taking saved initial outlay and deductiing tax adjusted lease payments and the lost capital allowanes. accountant discounted the net cash flows at the post tax cost of borrowing. resultant NPV is postive.
what would be the conclusion of this decision?answer is lease is better than buy.
sir as per my understanding initial outlay is relevant cashflow for buy decision and lease payment is relevant for lease decision.
lost capital allowances are probably tax saving on capital allowance. how are each one concluding to the answer that lease is better?Usually (as you will have seen from my lectures) we set up two sets of flows, one set being the lease flows and the other being the buy flows. We then calculate the present value of each set of flows and see which one has the lowest PV.
What has happened here is that instead of setting up two sets of flows, the accountant has just listed the difference between the two sets (the buy flows less the lease flows) and calculated the NPV of these differences. If the NPV is positive then it means the lease flows have a PV lower than the buy flows, and leasing is better.
(If you are still unsure then try it yourself on an example and you will then see what happens 🙂 )
thank you so much sir. i did not think that examiner can ask in this way too but now i understood thanks a lot.
i have one more question regarding this mcq and it is that, can the answer to lease vs buy scenario be +NPV which would mean that we will choose the higher benefit (instead when the NPV is negative it means we choose the lowest cost option).
in this mcq above, how do we know that +NPV is benefit or cost?
i hope you understood my questionWhen choosing between lease and buy we want the lowest present value.
When looking at the differences in this specific question, the NPV of the differences is +’ve it must mean that the the PV of the lease flows is lower than that of the buy flows and so leasing is better.
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