lag in tax relief

It is because the first lease payment is at the start of the year.

So…..the tax will only be calculated at the end of the year, and then there is a one year delay in tax. That means it is two years before they actually get the benefit of the tax saving.

When you are using DCF, time 1 does not mean year 1 – it means in one years time. (That is why we discount a flow at time 1 for one years interest).

A delay of 1 year means that tax is payable one year after the end of the accounting period.

We usually assume that operating cash flows (i.e. income statement items) occur at the end of the accounting period. So the operating cash flow in the first year is assumed to occur at the end of the year – i.e. in one years time, or time 1. The tax is calculated at the end of the year and is payable one year later – i.e. in two years time, or time 2.

The only time you will see different in the exam is with leasing, because if the lease payments are at the start of the year, then the first years payment will be made immediately – i.e. at time 0. The tax will not be calculated until the end of the year – i.e. in one years time – and will then be payable one year later – i.e. in 2 years time, or time 2.

(All of the above is assuming that the question says that tax is payable with a one years delay)

The only time you will see this problem with the timing is in a lease and buy question. Otherwise (as I have said above) we assume operating cash flows occur at the ends of years (which of course is not true in real life – they will be spread throughout the year.)