december 2009 question 1(ASOP)

No. The question says that lease rental includes the licence fee. The licence fee is only an extra cash flow if they buy the machine.

Hi dear Tutor again, I really confused in part a and b, and I will explain where I was stuck. Let us first start part B because solved it on the blank and compared it with answer. In part b, my cost savings and tax calculation are correct but why tax benefits have not been considered in this example?I included tax benefits Years----------------------0--------------1---------------2--------------3-------------4-----------------5 operating cost saved----------------------- 365400------ 479588--------637851-----563995 Cash flow before tax----------------------------------------------------------------------------------------- tax in one year arreas------------------------(109620)-------(143876)-----(191355)-----(169199) tax benefits-----------------------------------75000--------------56250---------42188-------96563 the rest I discounted with 11% as it is nominal DR. Why tax benefits have not beenn taken into consideration here? In Part A, why tax benefits have been calculated over licence fee?,besides tax benefits over machine-which is understandable I am really confused why tax benefits have not been taken into account in part B and why tax benefits have been calculated over licence fee? From my own point of view, licence fee could be considered here as goodwill or patient which is not depreciated and direclty calculated tax benefits but if tax benefits calculated why i do not include it INITIAL INVESTMENT figure of 1000mln?

In Part (b) the tax benefits have been taken into account - the present value of financing (974,762) is included in arriving at the NPV. (But as the examiner states in his answer it is also acceptable to show the initial costs and the tax flows separately). In part (a), the licence fee is an expense and the expense is tax allowable. It is included in the lease payments and so does not need including again, but it is an extra expense if the machine is bought. It has nothing to do with depreciation - it is an expense each year. Have you watched my free lectures on lease v buy???

Yes I wacthed but it is first time I faced this kind of case.I am almost solving all questions when i watched your lectures.Your lectures helped me too much about understanding questions. In my calculation, my answer is 1323052 compared to the examiner's answer of PV of benefits 1135557. this is because in part b calculation, tax benefits have not been taken into consideration as it has already been taken into account in part a calculation therefore the examiner did not include it for the second time but used part a's present cost of financing which is part a calculation 974762.-this amount includes tax benefits. now I understood.

That is great that you now understand :-)