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If license fees is $104000 per annum and inflation is 4% per year in each subsequent year.
annual lease payment is $380000 per year , payable in advance at start of each year. Annual lease payment includes cost of license fee.
Tax rate 30% in arrears , after tax weighted average cost of capital is 11% per year. Loan paying interest at annual before tax rate of 8.6% per year.Pls tell npv for lease.
No!
This forum is not to provide full answers to full questions.
You should be using a Revision Kit from one of the ACCA Approved Publishers. If you are then you will have an answer and you should ask about whatever it is in the answer you are not clear about and then I will explain.
If you do not have an answer for some reason, then you will presumably have watched my free lectures on lease and buy. So if you type out your answer I will tell you whether or not your answer is correct (and if it is not correct then I will explain why it is not).
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(a) After-tax cost of borrowing = 8.6 × (1 – 0.3) = 6% per year
Evaluation of leasing
Year Cash flow Amount ($) 6% Discount factors Present value ($)
0–3 Lease rentals (380,000) 1.000 + 2.673 = 3.673 (1,395,740)
2–5 Tax savings 114,000 3.465 × 0.943 = 3.267 372,438
––––––––
(1,023,302)
––––––––Doubts-
1) Why license fees is not inflated in lease rentals?
2) Why wacc interest rate is not used?The wording of the question as you have typed it implies that the lease payment is fixed. When a lease is agreed it is not normal for the annual payment to increase.
To decide which is the cheapest between leasing and buying we discount at the cost of borrowing. That checks whether leasing is effectively costing more or less that the 6% that is payable if we borrow and buy.
I do explain this in my lectures.
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