Application of DCF Technique (2)

Question 1

Implications for lease-versus-buy decision process if business is not in a tax-paying position?

Answer 1

No tax benefit from TAD if the asset was bought

No tax benefit arises from the lease payments

There would be no tax shield on debt

Question 2

What does no tax shield on debt mean?

Answer 2

The discount rate to use to evaluate the financing options should be the pre-tax cost of debt

Question 3

Situations where a business is not in a tax-paying position include?

Answer 3

Losses in current year

Losses are brought forward from prior years

Tax holidays granted by the host government

Question 4

Borrow to buy (bank loan)

Answer 4

Bank loan (or loan notes) will be recorded in non-current liabilities, increases gearing

Question 5

Borrow to buy (interest)

Answer 5

Interest on the debt will reduce the company’s interest cover

Question 6

Borrow to buy (Retained profit)

Answer 6

Increases the level of equity

Question 7

Lease (asset and related liabiltiy)

Answer 7

Both the asset and a related liability would be recognised in the statement of financial position

Question 8

How are lease payments split?

Answer 8

Between interest expense and repayment of principal and therefore the liability would amortise (i.e. reduce) over time and ultimately fall to zero

Question 9

When is buying an asset the preferred option in a lease-buy?

Answer 9

Fundamental importance to the business

Management wants to have absolute control over the asset

The asset is easily maintained

Question 10

When is leasing an asset the preferred option in a lease-buy?

Answer 10

Asset may only be needed for a short time

Asset needs to be regularly updated or upgraded

Asset requires specialist support or maintenance