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

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  1. From ACCAwebsite, FM, chapter -6 and activity -6, “Lease vs Buy”, option A’operational benefit” , could you please guide me in arriving the annuity factor, it’s 1.578 vs 2.487 (@10% 3 yr) per annuity table.please advise

  3. sir you said tax is payable one year later , outflow of 35000 at 1.1.2017 at T 0 we calculate tax at 31122017 a year later ? how is that a year later and into the next accounting period , we are still in the same accounting period that is T 0 a year later would be T 1 31 12 2018, to my understanding , thankyou soo much ?

    • Between 1 January and 31 December is 1 year (we are not bothered about 1 day) and therefore a cash flow on 31 December 2017 needs discounting for 1 years interest. If the tax is payable 1 year later then it is payable on 31 December of the following year and therefore needs discounting for 2 years.

  5. Hi John, Thank you for the lecture.
    I got one question “how can we know the lease contract is capital leasing or operating leasing”??
    Or, unless the question specifies, do we assume the lease is operating lease??

    Thank you.

  7. Hi Mr John ,
    Thanks for the lecture ,

    My question is ,isn’t it and supposed to be that year 0 and year 1 they are the same year ,
    i.e they are one year

    the only difference is that Time 0 is the beginning of the year 1 and Time-1 is till the end of the first year
    is my understanding correct ?

    Thanks

    • Time 0 is the start of the first year.
      Time 1 is the end of the first year/start of the second year.
      Time 2 is the end of the second year/start of the third year.
      and so on.

      It matters because we are discounting always for 12 month periods and a flow at the end of the first year needs discounting for one year to get back to present value.

      Have you watched the earlier lectures on investment appraisal?

      • Hi Sir,

        I understood now why the tax allowances were for five years because we bought on 31-dec-2016 and time 0 will start 1.1-2017 .

        But my question is it possible that the no of allowances will be more the life time of the assets which is here 4 years in this example and the allowances are for 5 years.

        Thanks

  9. Hi John, thank you for these invaluable lectures! With regard to this lecture, I have a question.

    When we decide to lease the machine, wouldn’t an opportunity cost be the tax saving from buying it? Why do we not calculate the net tax saving (tax saving of leasing – tax saving of buying) when evaluating the lease option? (Same question applies to when evaluating the buying option.)

    Because, I assume we have decided to undertake the project either way and will ultimately either buy it or lease it.

    • Similarly, if we decide to buy the asset I guess there would be a saving on the lease payments as an immediate consequence and therefore, there should be an inflow to that extent in the buy appraisal? I guess this applies to every cash flow that wouldn’t happen if the other decision is taken.

      • There are two ways that you can set up the flows.

        One is to set out the lease flows and the buy flows (with the associated tax savings for both) separately (as I do in the lecture) and then choose the one with the lowest PV.

        Alternatively set out the differences between the two flows and calculate the PV of these differences. The decision will be the same.

        To do the first option but show tax savings etc as well would be effectively double counting and would be wrong.

  10. Sorry for the wrong questions above,

    My question is as per 3rd video of chapter 8 which is in relation with the tax (DCF) , we were not having any capital allowance in the last year of the machine except for balancing charge and balancing allowance whereas, in this video in case of buying we are having a capital allowance in 4th year and balancing allowance in 5th year?

    Please explain ?

  14. Dear Sir John,

    Thanks for the lectures.

    My question is in year 5 why did we not Deduct the cost from the Scrap value and take the tax % age to get the balancing figure to use as a capital allowance like we did when calculating the NPV questions.

    • I have found the question, but I am puzzled by your question because it is not a lease and buy question. When calculating the NPV of a project we always discount at the cost of capital, and the cost of capital is always already after tax.

      • Hi John,
        I wrote my question in the lease & buy lecture because that where you explain after-tax interest rate. I am confused when we should deduct the tax from the discount rate and when we should not.
        In many question it is explicitly written after-tax discount rate is xx% (e.g. question Degnis Co). But in question Ufnit Co it is written weighted average cost of capital is 12%. So I thought we should deduct the taxes from the discount rate. But no, in the answer the 12% discount rate is applied for the NPV calculation.
        Or are you saying that regardless the wording in the NPV question we should always assume that the discount rate is already without the tax?
        Thank you,
        Daria

      • The weighted average cost of capital is always after tax unless the question specifically says that it is given pre-tax. (Just as I wrote in my previous reply). Have you not watched my lectures on the cost of capital?

  16. Dear John,
    could you please clarify when and when Not to remove the taxes from the interest rate? For example in question 163 on page 60 BPP “Practice & revision Kit, FM” for the exams Sep 22-Jun 23 they dont remove the tax from the interest rate and apply full 12% for the NPV calculation.
    Thanks a lot in advance!
    Daria

  17. Dear Sir,

    You can ignore my last question. I looked at the way the answer is structured in the lecture notes and I seem to have understood now.

    On the other hand, just to confirm the logic, is it correct if I say that there is an additional year of capital allowance due to Taxation rules, yet in terms of depreciation it is still 4 years which is based on the actual usage of the new machine?

    Thanks again.

    Regards,
    Tim

  18. Dear Sir,

    Thank you again for another great lecture.

    I understand that there is a 5th year (or Time 5) of capital allowance/depreciation due to the actual usage of the new machine. However, why would we already account for the Scrappage at Time 4? The scrapping is done only at end of usage which should be in Time 5?

    Much appreciated for your guidance in advance.

    Regards,
    Tim

  19. It wasn’t done till year 5.

    There is depreciation in the year in which the asset is bought and for each of the years it is used.

    Usually, assets are bought on the first day of an accounting period, and if it is lasting 4 years then there are 4 years of allowances.

    If the asset is bought on the last day of an accounting period (as is the case in this example) then there is depreciation for that year and then also for the 4 years it is used (so 5 years in total).

  20. Dear Sir John,

    Can I conclude if the payment of the equipment was made on last day of the month, the depreciation of the equipment will have to be done till Year 5 even the sales proceed was in Year 4. Where-else if the payment was made on 1st day of the month, the depreciation will have to be done only till Year 4, assuming the sales proceed was on Year 4

    Thanks

    • Months are not relevant. If the machine is purchased on the last day of an accounting period then there will be tax allowable depreciation calculated at time 0 and for each of the following 4 years.
      If it is purchased on the first day of an accounting period then there will be tax allowable depreciation just in each of the 4 years in which it is used.

      When the benefit of the TAD is received depends on whether tax is payable immediately or with a one year delay.

      Have you watched the free lectures on investment appraisal with taxation where the tax rules are all explained?

      • Dear Sir John,

        Yep. I did. I was doing a comparison between the topic – “dcf-taxation” and “lease versus buy”. I realised that the depreciation done for the years of sales proceed was different.

        For example in dcf-taxation, the depreciation was done till the year where the machine was sold. Sales proceed was in year 4. We do the depreciation till year 4

        But for lease vs buy, it was done till the year 5, even the sales proceed was in year 4.

        I am trying to find the similarity between this 2 topic.

      • Ehsan: IFRS’s are of no relevance to the financial manager (or to Paper FM as a result). They are the ‘rules’ for Financial Reporting and therefore relevant only for the Financial Reporting exams.

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