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Business finance and COC

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FM Exams › Business finance and COC

  • This topic has 3 replies, 2 voices, and was last updated 3 years ago by John Moffat.
Viewing 4 posts - 1 through 4 (of 4 total)
  • Author
    Posts
  • August 26, 2021 at 3:49 pm #633043
    Nikitagarwal
    Participant
    • Topics: 154
    • Replies: 147
    • ☆☆☆

    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 #633048
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54700
    • ☆☆☆☆☆

    As 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 #633450
    Nikitagarwal
    Participant
    • Topics: 154
    • Replies: 147
    • ☆☆☆

    yes sir , but where is 6% coming into picture?

    August 30, 2021 at 8:11 am #633472
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54700
    • ☆☆☆☆☆

    8% is pre-tax, the after-tax cost of the loan is 8% – (25% x 8%) = 6%

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