Hi Sir,
please could you help with the following, it is part of a section C question on lease VS buy,
" the company would pay four annual lease rentals of £380,000 per year,payable in advance at the start of each year"
the before tax rate is 8.6% per year which give Discount factor of 6% as it is debt and tax applies, however i understand in first year tax wont apply to the lease as tax is payable in arrears however instead of minus the discount factor of 6% 3.465-0.943 which gives annuity factor of 2.522 they times 3.465*0.943 and use the annuity factor of 3.267?
hope my question makes sense it is question 31 in section Kaplan revision kit.
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Annuity factors
5y ago#1Because the lease payments are paid in advance and the tax is one year in arrears, the first tax flow will be at time 2 (as I explain in my free lectures on this).
The tax flows therefore occur from times 2 to 5.
You can discount this in either of two ways:
One way is to take the 5 year annuity factor less the 1 year annuity factor (so as to be left with times 2 to 5). This gives a factor of 4.212 - 0.943 = 3.269
The other way is to say that there are 4 years of flows and so to take the 4 year annuity factor of 3.465. However this would give a PV now if the first flow were at time 1. Since the annuity starts one year late (at time 2 instead of time 1), the PV needs discounting for 1 year.
This gives a factor of 3.465 x 0.943 = 3.267
Either way is fine - the small difference is due to the fact that the tables are rounded to 3 decimal places, and this is irrelevant for the exam.
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