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ACCA Applied Skills · Financial Management · Specific investment decisions (lease or buy, asset replacement, capital rationing)

Kappa Co can lease a machine for $50,000 a year, payable at the end of each of the next 3 years. Tax is 20% and tax relief on lease payments is received in the same year as the payment. The post-tax discount rate is 10%. The 3-year annuity factor at 10% is 2.487 and the 4-year factor is 3.170. What is the present value of the net cost of leasing?

The present value of the net lease cost is $99,480. Lease payments of $50,000 are reduced by 20% tax relief received in the same year, giving $40,000 a year, which is discounted for 3 years at 10% using the factor 2.487.

  1. A$99,480Correct
  2. B$124,350
  3. C$149,220
  4. D$101,740

Explanation

Net annual cost after tax relief = $50,000 × (1 − 0.20) = $40,000. PV = $40,000 × 2.487 = $99,480. $124,350 ignores tax relief. $101,740 wrongly delays the tax relief by a year. $149,220 adds the tax relief instead of deducting it.

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