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Discounted Cash Flow Further Aspects, Lease versus Buy – ACCA Financial Management (FM)

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    • The question says that the lease payment are payable at the start of each year. Therefore the first payment is at the start of the first year, which is time 0.

      (If bought, then the cost is payable on the last day of the current year, which is also time 0.)

  2. Hi Sir, do we take account of opportunity cost such as saved initial outlay and lost capital allowances when doing lease vs buy or replacement questions?

    • I assume that you are referring specifically to lease and buy calculations given that you have posted this as a comment on a lecture on lease and buy.
      We always use the after tax cost of debt (not the cost of capital) when deciding between leasing and buying (unless obviously the question specifically says to ignore tax!).

      • No Sir, I was also referring to normal NPV. How do we know when to use pre or post tax discount rate?

  4. Sir why are you using Interest cost after tax (7%) in this question, although you did calculate interest cost of 10%? Previously, you never told us to discount cashflows at interest rate after tax. I have understood the relationship between interest cost after and before tax, but discounting at 7% worries me.

    • We are comparing the cost of leasing with the cost of borrowing and buying. If they borrow then the interest as always is allowable for tax and therefore the net cost to the company is the after-tax interest.

      Later lectures look in more detail at the cost of capital and the impact of tax.

  5. Dear John,

    Many thanks for the lectures.

    I understand the reasoning behind why the capital allowance is calculated over 5 years in this case, but what I don’t understand is what distinguishes it from the capital allowance in Chapter 9, Ex. 4? – where the machine has a 3 year operating cycle and the purchase is performed at Time 0, but we only recognized 3 years of allowance. Shouldn’t the allowance have been recognized 4 times in that example?

    Thanks!

  6. Dear John,

    Many thanks for your time and effort for preparing the lectures. May I ask you why the buying cost is in Time 0 as the question says it will be bought on the last day of the current financial year. why it is not in Time 1 which is the last day of first year and first day of the second year?

    Kind regards,
    Zhu

  8. Hi Sir, many thanks for your lectures. However, I am a bit confusing in the balancing allowance. Since the machine will be scrapped at year 4, why we net off the scrap value at year 5 rather than net off at year 4?

  9. Hi sir,
    I would like to thank and appreciate you for your efforts. i do have a doubt as to why you haven’t charged tax of 30% to the cashflows prior to the tax savings column as you have done in your previous lectures on Relevant cash flows for DCF Taxation (example 4).

    • There is no such thing as year 0.
      0,1,2 etc are points in time that are 1 year apart. Time 0 is ‘now’ – the start of the first year. Time 1 is 1 year away – the end of the first year and start of the second year, time 2 is another year later – the end of the second year and start of the third year, and so on.

      I explain all this in my earlier lectures on investment appraisal.

  11. Thanks a lot for the lecture. However, I am a bit confused with the tax savings of the machine for example 3.

    As you explained, the machine will receive 4 years of capital allowance for operating + 1 year of allowance for scrapping. But if contrasted to the last chapter (Chapter 9 Example 4), the machine has 3 years of operating life but only 3 years of allowances are received. What differentiates the 2 problems?

    Thanks a lot!

  12. Hello Mr. Moffat.

    I want to say that I really enjoy your lectures and I really appreciate your time and effort you put into delivering those to us!

    I have a question regarding the tax timings though. I understand the logic on why we put the tax saving in a later timing. The thing which I do not understand is why, on the lease decision we put the tax saving on time 1 and in the buy decision we put the tax saving on time 2. Shouldn’t those be on the same year in both cases, and more specifically in time 2?

    Thank you in advance,
    Georgios

    • It is the other way round – the first tax saving when we lease is at time 2 and when we buy it is at time 1.

      I do explain this in the lecture (and in the earlier lectures on investment appraisal with tax).

      If the question says that tax is payable with a one year delay, then it is payable one year after the end of the accounting period. So if a flow occurs at the end of an accounting period (as it does when we buy in this question) then the tax effect is 1 year later. If a flow occurs at the start of an accounting period (as it does when we lease in this question) then the tax effect is 2 years later (one year until the end of the period and another year delay on the tax).

    • I do explain this in the lecture (and in the earlier lectures on investment appraisal with tax).

      If the question says that tax is payable with a one year delay, then it is payable one year after the end of the accounting period. So if a flow occurs at the end of an accounting period then the tax effect is 1 year later. If a flow occurs at the start of an accounting period then the tax effect is 2 years later (one year until the end of the period and another year delay on the tax).

  14. Hello, please if in the question you are given cost of capital as 20% and cost of borrowing from the bank as 14%, how do you decide on the discounting factor rate to use ?

  19. I really do not understand why in Lease table you account for Tax saving as 30% of lease payment. Is it something usual for Britain? If you lease you have not to pay tax for property, so you should 30% multiply to potential property balance, no?

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