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In calculating the npv of purchasing the new technology,there is a tax deduction . I don’t understand 1-why its calculated on the licence fee and 2-why its shown as a positive value, i.e. a deduction. I thought tax relief was only for leases.
Surely, any expenditure will reduce the taxable profit of the company and therefore will save them tax? This is Paper F6.
OK – lease payments will reduce the taxable profit and save tax, but so too will any expenditure.
Have you watched the lecture on this (or been through it in your Study Text)?
It is the standard rule for lease and buy that to decide which is cheaper of the two we discount at the after tax cost of borrowing.
sorry forgotten just had quick review of topic 4 in chap 9
thank you soo much for answering and remindingNo problem! (We only use WACC when we are appraising projects – choosing between leasing and buying is not appraising a project).
Hello, I don’t understand why in part A, a discount factor of 6% (which is after tax) is used but in part B , a discount factor of 11% is used
Its really what I was saying in my previous answer.
In part (a) we are not appraising a project – we are simply seeing whether or not leasing is cheaper than borrowing and buying. For this we discount at the cost of borrowing (after tax).
In part (b) we are appraising the project and as usual when appraising projects, we discount at the WACC.
(It will be worthwhile you watching my free lecture on this. Although because it came up in last times exam, it does mean that it is less likely this time.)
Hi Sir,
I dont understand that in part a, its mentioned “financing cash flows only”. What is the difference? Not considering operating cost? If this is the case then why are we considering license fee?
And in part b , its taking account of operating cost where as in part (a) its not?
In part (a) you are deciding on the cheapest way of getting the machine – lease or buy.
In part (b) you are deciding whether or not the machine is worth having at all.
So, for part (a) you are simply comparing the flows that will occur if we lease, with those that will occur if we buy. There is no point in bringing in the operating costs etc because they will occur whichever we choose.
In part (b) when we are deciding whether or not to invest in the machine at all, we need to bring in all the operating flows as usual.
(It might be worthwhile watching my free lecture on this)
Hi
I’ve watched this lecture and it’s great. One question though:
Why aren’t interest payments included as part of the evaluation of the buying decision? Wouldn’t this be a cost of purchasing the machine too?
Thank you for your time 🙂
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