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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.
Because 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 = 3.267Either 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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