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ACCA F9 Discounted Cash Flow Further Aspects, Lease versus Buy
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Dear John
I just want to say thank you sooooooooooooo much for the brilliant lectures. I have been living with your lecturers in the last couple of months and I have done to paper today and I feel pretty positive, thanks to your brilliant style of teaching. If you ever decided to teach in London I will be your front line student. thank you.
Great – I am glad that the exam went well 馃檪
Mine went better then last time as well, Thanks to you and your hints 馃榾 What other subjects you teach?
F2, F3, F5 and P4.
Oh so i’ll have to take P4 then 馃榾 Thank you once again, everything you taught was perfect. I feel if i had given more time to my studies and your lectures this exam was the one in which i could have scored very good score.
Hi John,
Thanks for clearing up the payment and timing of tax for me. It always confused me but not any more! Thanks a lot!
For the lease buy decision you should discount the flows at the after-tax cost of borrowing.
In ASOP the before tax cost is 8.6%, and so the after tax cost (with tax at 30%) is 8.6 x 0.7 = 6.02% – so discount at 6%
With regard to the discount factor itself, because the payments are made in advance, the first payment is at time 0, and then there are payments at times 1, 2 & 3.
The discount factor for a payment at time 0 is 1.
The discount factor for an annuity at times 1 to 3 is the 3 year annuity factor at 6% = 2.673
So….either discount the two bits separately and then add up, or multiply the figure by the total of 1 + 2.673 = 3.673
(PS If you ask about specific questions, please say where the question is from. I can’t remember the name of every exam question that there has ever been, and it takes ages for me to find it 馃檪 )
Why are the flows in the buy decision also discounted at 6% when only the lease payments are tax allowable?
Because you are comparing with the cost of borrowing to see which is cheaper.
Good evening, John!
Could you, please, help on the following question: i tried to do question from December 2009 Exam # 1 regarding lease or buy the new technology, and I’ve got the following question:
why when trying to find option 1 – bank loan license fees are included? nothing told about interest payable on loan, but license fees are calculated, and what is more, tax saving on license fee is given.
And just would like to clarify general approach:
1) when we use option bank loan – we have non-current asset, and as result we have tax saving on WDA, which should be included into calculation of CFs, besides we should include interest payable on the loan + tax relief. Is this all regarding taxation?
2) when we use option leasing – we only have lease payments and tax relief on the lease payments?
Thank you in advance!
As far as the lease or buy decision is concerned, if we lease the machine then the only payments are the lease payments (they include the license fee) and we get tax relief on the lease payment.
If we buy the machine, then we get the tax saving on the capital allowances. In addition there are the license fees an we get tax relief on these. We do not bring in the interest payments (or the tax relief on them) because these are taken account of by the discounting.
hi sir i have a question if the question does not state when the asset is bought but says it has a year end of 31 december and that the 1st payment is made in january when do i claim WDA year 9 or year 1
year 0 or year 1
You would assume that the asset was bought on 1 January, and therefore if you are told that ‘tax is payable immediately” you would get the first tax saving at time 1. If you are told that ‘tax is payable one year later’ then you get the first tax saving at time 2.
( if you are not told when tax is payable the assume ‘tax payable immediately’ but state your assumption )
thank you
hi sir im doing a question and it says the accounting year ends on 31december,if the machine is purchased,payment will be made in january of the first year of operation,if leased annual lease rentals will be paid in january of each year of operation…my question is when will i claim WDA in year 0 or year 1
Another night with John Moffat 馃榾 6 am going to bed!!!! Really enjoying these lectures. I was dreading this exam.
Sir, before making the decision for whether to borrow to buy of to lease the asset through the finance or operating lease , is it mandatory that we must compute the NPV for investment (acquisition) decision even when it is not required ? eg saying no cashflow was given but cost savings was given
No – if the investment decision is required then the question will say so.
Hi John, CA for 100,000 is 7500 in year 1, why there are other CA on year 2-5? Where do I get the number 18750, 14062.
I get it, thanks anyway
Glad you have sorted it 馃檪
@johnmoffat: I am doing a question in the revision kit where the machine will be used for 4 years and at the end of that time it will generate scrap proceeds of 20,000. The question states that “a full year’s allowance is given in the year of acquisition but no writing down allowance is available in the year of disposal. The difference between the sale proceeds and the tax written down value in the year of disposal is allowable or chargeable for tax as appropriate.” In the answer tax is not calculated on the sale proceeds of 20,000. Also the capital allowance tax saving is claimed on the written down value in the 4th year and claimed again in the 5th year after sale proceeds is deducted. You taught that sale proceeds should be deducted in the year the asset is disposed of and tax calculated on the sale proceeds.. This is somewhat confusing to me. Can you please explain? Thank you.
I would have to see the question to give a firm answer.
From what you have written, it would seem that the full 20,000 should be taxable. I can only assume that it is at time 5 because there is a one year delay in the tax.
Tax is payable 1 year after the end of the accounting year. The 20,000 was not taxed. The question is from a dec 2002 past paper. Leaminger. Thank you.
I still don’t understand how the “last day of the current financial year” is year 0 when it comes to buying the machine. I would think this would be year 1 as the question did not say the machine is bought at the start of the year or now. Please help me understand. Thank you.
I read through the notes and I have understood my question.
We usually regard the time of buying the machine as being time 0. (Not year 0 – we are looking at points of time, not years.)
The only relevance of the fact that ‘now’ is at the end of a year is the tax effect.
i wanna to ask why in the ex of lease or buy we dnt deduct the tax @30% as we do b4 in all ex
@aelsewy, The example does deal with the tax.
The lease payments result in a tax saving, and the buying results in a tax saving from capital allowances.
thanks for the video..so just to double confirm..can i say year 0 is the beginning of the 1st year,and lease payment are paid at the start of each year,thats why its computed in yr 0.As for the tax saving for lease payment..year 1 is like the end of 1st year so there will be tax saving in year 1,however tax is payable a year later,so thats y its computed in year 2?…….and as for capital allowances,asset is bought at the end of the accounting period 2010,so i agree that we claim it at year 0 however tax is payable one year later so again,tax saving only occurs starting from year 1.
sir,i did some past year papers and the question did not say the asset is bought at the end of accounting period.and the answer claimed its capital allowances on year 1 and tax payable on year later,so tax saving from capital allowances is on year 2.why is it that the capital allowances are claimed in year 1?do we claim our capital allowances in year 1 as d default basis when the question did not say when the asset is bought?
secondly,there is this question i did,it did not say when the asset is bought.however it does say that the company is able to fully utilise its allowances throughout the project and its capital allowances is claimed at year 0…
ive talked to some students who passed their f9.and they told me capital allowances are always claimed on year 1 unless the question told me to claim it at year 0.so im really confused here 馃檨
@flippy, Usually you are not told in the question the date on which the asset is bought. For the exam therefore you assume that the first capital allowance saving occurs at the same time as the first charge of tax on the profits. With a one year delay in tax this is at time 2.
The only time that the timing of the capital allowance saving is likely to matter is in a lead and buy questions (watch the lecture on lease and buy).
Otherwise questions never tell you whether allowances are claimed at time 1 or time 2 (what other students have told you is not true). Always assume that the first CA saving is at the same time as the first tax is payable on profits (unless the question actually gives dates, which these days is very unlikely indeed).
@johnmoffat, right,what about this question i did..its not about lease/buy decision but the answer given claimed its capital allowances at year 0,and tax payable one year later is at year 1.However it does state that the company is able to fully utilise its capital allowances throughout the project.does this sentence tell us that we need to claim our capital allowance at year 0?tax delay year1.
@johnmoffat, and i have another question,if lease payment are paid in advance,it is not the same meaning as lease payment paid at the beginning of the year right?.thus my tax saved on lease payment will be computed in year 0 and if there’s tax delay,then year 1.correct?again im sorry for being so annoying by asking so many questions 馃檨
accounting conventions in conjunction with timing in discounting can be confusing. now, i got a clear picture of it.
f9 students must listen to it.
Sorry for trolling, but why for the buy part it makes capital allowance for 5 years and not for 4 years ?
@andreivoinescu1987, Because it is bought on the last day of the current accounting period, it means that it gets capital allowances for that year and then for each of the four years it is used. So 5 in total.
Not finished the lecture yet so maybe it gets corrected but it says “If the machine is bought, it is bought on the last day of the current financial year”. Wouldn’t that mean it is bought in time 1 and not time 0? Any help would be appreciated.
@miller215, I will learn the art of waiting, it gets answered, although i would have read it differently if not watched the lecture 馃檪
@miller215, I hope it makes sense now OK 馃檪
I’m a bit unclear about the tax saving being a cashflow in year 2.
As usually the operating cashflows are taken to be at the end of the year (say year 1) and the tax being payable an year later, which would be in year 2.
However in this case, regarding the lease the cashflow is taken to be at the beginning of Year 0 but it says the tax cashflow happens in Year 2?
It says in the Lecture, tax is calculated at the end of Year 0, and being paid an Year later being at the end of Year 1??
Is it possible to explain this in line with how it works in the usual scenario where the tax is paid an in year 2 – i.e where the cashflow for which the tax is payable occurs at the end of Year 1 and where the tax cashflow occurs in Year 2?
@statistics, Probably I should have waited until the end of the lecture to post this – the Rule at the end sort of clarifies this.
how come tax is saved on leasing?
is it a rule/fact ?
@pinky, For Paper F9 it is a rule (unless obviously the question says differently).
Please fix your PC then,, we can’t do it for you.
video is working fine
@admin, video not working, i get feedback that server not found, what is the way out admin?
@achiever06, contact your Internet Service provider to fix this for you,
no sound for 2 days.