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A lease versus buy evaluation has been performed. The management accountant performed the calculation
by taking the saved initial outlay and deducting the tax-adjusted lease payments and the lost capital
allowances. The accountant discounted the net cash flows at the post-tax cost of borrowing. The resultant
net present value (NPV) was positive.
Assuming the calculation is free from arithmetical errors, what would the conclusion for this decision be?
i) Lease is better than buy
ii) Buy is better than lease
iii) A further calculation is needed
iv) The discount rate was wrong so a conclusion cannot be drawnSir, I don’t understand this question. First of all what is the saved initial outlay? Second, what are LOST capital allowances? And third, is a lease evaluation being performed or a purchase evaluation or both in this question?
Normally when deciding whether to lease or buy we set up the cash flows for each separately, discount at the post-tax cost of borrowing, and choose whichever of the two has the lower NPV.
The question says that instead of setting up two sets of cash flows, the accounting has just put them all in one instead of showing them separately. So if there were to lease, they would obviously have all the lease payments as normal, but they would not be buying and so would save the initial cost of buying and would lose the tax saving on capital allowances.
So the resulting NPV will be the difference between the PV of leasing and the PV of buying and depending on whether it is positive or negative will indicate which is the better option.
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