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The lease will be over 5 years with lease payments of $146,000 annually (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.
Answer:
Years 1-5 maintenance of $20,000 and years 2-6 tax savings on the maintenance costs discounted at 6% discount rate.Annuity factor 5 years at 6% = 4.212
$(20,000) x 4.212 = $(84,240)
$20,000 x 25% x (4.917 – 0.943) = $19,870Net PV = $(64,370)
My question:
Where does they say that the has any tax saving on the maintenance, I really am confuseThe maintenance costs of $20,000 per annum are payable by the lessor at the end of each year. Since these costs are incurred by the lessor, they are not directly tax-deductible for the lessee. However, the tax implications arise from the tax relief on these maintenance costs.
The tax relief on the maintenance costs is based on the corporation tax rate of 25%. Therefore, the tax savings from the maintenance costs for each year is calculated as 20000 * 0.25 = 5000
The tax savings are realised in the year following the maintenance payment.
Thus, the tax savings for years 2 to 6 are discounted back to present value using a discount rate of 6%.
The annuity factor for 5 years at 6% is 4.212, and the present value of the tax savings is calculated 5,000 * 4.212 = 21,060
The net present value of the maintenance cash flows, after considering the tax savings, is calculated by subtracting the present value of the maintenance costs from the present value of the tax savings.
The treatment of maintenance and tax involves recognising the maintenance costs as a cash outflow and calculating the tax savings from these costs, which are then discounted to present value to assess their impact on the overall financial analysis.
So the NPV provides insight into the net effect of these cash flows, allowing for better decision-making regarding the lease.
This is all explained with examples in my johns lectures. The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
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