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John Moffat.
John Moffat.-
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dennissherpa101
- Topics: 43
- Replies: 56
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SIR IS THE INVESTMENT DESCION TAKEN FIRST OR THE FINANCING DESCION. IF INVESTMENT DESCION IS TAKEN FIRST THEN WHAT IS THE COST PUT UP AS? THE PURCHASE COST? AND WHEN DISCOUNTING I UNDERSTAND BY POST IT ITAX USED AS DISCOUNT FACTOR FOR WHEN BOUGHT BUT I DON’T UNDERSTAND WHY IT IS TAKEN FOR LEASE?
John Moffat
- Topics: 57
- Replies: 49993
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Please do not type in capital letters 🙂
If they are buying then as with any investment the initial outflow is the purchase cost.
When discounting we always use the after-tax cost of debt in a lease / buy question (unless the question specifically says to do different) because the cost of borrowing for the company is after-tax and we are discounting in order to see whether the cost of leasing is higher or lower than the cost of borrowing.
dennissherpa101
- Topics: 43
- Replies: 56
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Sir if we are leasing then would there be a purchase cost in year 0? if not will we add lease payments with the revenues( this is for the investment descion) we are using post tax on the lease payments what about the net operating cashflow what rate will be discount by?
John Moffat
- Topics: 57
- Replies: 49993
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No. Leasing is like renting – there is no purchase cost. The lease payments each year are an expense, and in order to compare with buying we discount the leasing flows at the after tax cost of debt (the debt that would be used if we were buying).
The revenues are not relevant for this decision because they would be the same whether we buy or whether we lease.
dennissherpa101
- Topics: 43
- Replies: 56
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so before we accept any project will we first consider both leasing and purchasing option?
John Moffat
- Topics: 57
- Replies: 49993
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No, not at all.
In exams we only compare leasing and buying if the question specifically asks for us to do so.
(In practice, companies may consider the option but they certainly do not have to.)
dennissherpa101
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