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- This topic has 3 replies, 2 voices, and was last updated 2 years ago by John Moffat.
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- August 26, 2021 at 3:49 pm #633043
Ques – Brash Co can buy a new piece of sophisticated machinery for $500,000 by borrowing under
a secured loan at 8%. It has also researched the possibility of leasing the asset.
The company’s finance director is a little rusty on leasing issues as the business has never
leased before and he has worked in Brash Co for 20 years. He said ‘I studied leasing years
ago but I think leasing is cheaper than borrowing because the lease company has access to
greater amounts of finance and so benefits from economies of scale on that front’.
The managing director is sceptical, arguing that leasing companies are commercial and so
each deal must be assessed on its merits. He commented: ‘We have to careful here, I know
the lease companies are always responsible for the maintenance but that can’t be free!’
The lease offer is as follows:
The lease will be over 5 years with lease payments of $146,000 annually in advance (at the
start of each accounting period). Tax is payable 1 year after the accounting year-end and
the corporation tax rate is 25%. Maintenance is payable by the lessor and costs $20,000
per annum payable at the end of each year, including the last year in preparation for sale.
The residual value is expected to be $40,000 (the expected tax written down value at the
end of the lease) and the lessor will retain that.What is the present value of the maintenance cash flows, after tax?
where is it written that discounting rate is 6% ?
August 26, 2021 at 3:57 pm #633048As I explain in my lease and buy lectures, we discount at the after-tax cost of borrowing.
The loan is at 8% and the tax rate is 25%.
August 30, 2021 at 2:17 am #633450yes sir , but where is 6% coming into picture?
August 30, 2021 at 8:11 am #6334728% is pre-tax, the after-tax cost of the loan is 8% – (25% x 8%) = 6%
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