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ACCA FM · Guided practice (Show me how)

Chapter 9: Discounted cash flow – further aspects

Lease or buy - the financing decision

A company is considering whether to buy a new machine at a cost of $100,000 or to lease it for $35,000 a year, lease payments payable at the START of each year. Buying would be financed by borrowing at an after-tax interest cost of 7% a year. If bought, the machine will be bought on the LAST day of the current financial year (time 0).

The machine is needed for 4 years and, if bought, will have a scrap value of $10,000 after 4 years. Corporation tax is 30%, payable one year after the end of the financial year. Capital allowances are 25% a year, reducing balance.

Should the machine be leased or bought? Sign convention: inflows and tax savings positive, outflows negative.

  1. (a) Buying

    Calculate the company's buying cash flows, capital allowance tax savings and present value of net buying costs over the machine's life.

  2. (b) Leasing and the decision

    Calculate the company's present value of net leasing costs over the machine's life and state whether it should lease or buy.

Opening this exercise…