if in lease financing problem, two rate are given
1. borrowing rate before tax
2.cost of capital ( before tax or after tax is not specified in problem)
which rate will be use for discounting cash flow & for calculating equal annualized lease rent from the lessee point of view :-
1.borrowing rate after tax
or
2.cost of capital.
plz help
hie...do not be confused...
for discounting purpose u have to take "cost of capital" in all cases( after tax)...in case nothing is mentioned, make an assumption that the given rate is after tax and mention it in your working notes...this is used when u take the asset on lease..
in case u make calculations fr borrowing and purchasing the asset, take the rate at which the asset is borrowed.....
Revert if u are still in doubt..
Regards.!!
am i clear??
but in many cases i see that borrowing rate after tax is consider for discounting purpose.
and they mention the assumption that we are taking the decision for lease and borrowing of asset and not for the lease and purchase the asset.
also in A N SHRIDHAR BOOK and J B Gupta also give same assumption.
In J B GUPTA book also mention that where in problem if both rate are given & also discount factor is given for cost of capital then only use cost of capital for discounting purpose, otherwise used borrowing rate after tax for discounting.
Plz comment if i am wrong
i got the ans.
order of preference for discounting rate :-
1.if specific information is given follow that.
2. if no specific information is given then use borrowing rate after tax as discounting rate. if in problem cost of capital is given then it may be use for discounting cash flow.
just give assumption . both are valid option
3.last preference given to cost of capital.
in lease financing, if we are taken the decision from the lessee point off view then follow borrowing rate after tax, becoz we are taking financing decision and not capital expenditure decision. it is a decision of lease v/s borrowing and not lease v/s purchase.
give this assumption in exams
plz reply if i m wrong.
For lessee
1. If discount rate mentioned, then use it.
2. If discount rate not given but given borrowing rate and Cost of Capital then
- use Borrowing net of tax as discount rate. If it is Bank financing Vs. Lease financing qutstion
You can use another alternative also but above is best alternative.
- use cost of capital (the given cost of capital is always net of tax unless otherwise stated Hence no need to do net of tax) if it is Cash purchase Vs. Lease financing
For Lessor.
Always use Cost of capital as discount rate. no need to do net of tax because cost of capital itself is post tax (remember calculation of WACC.)
thanks Nagendra sir
| Originally posted by : amit | ||
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thanks Nagendra sir |
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| Originally posted by : CA Nagendra | ||
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For lessee 1. If discount rate mentioned, then use it. 2. If discount rate not given but given borrowing rate and Cost of Capital then - use Borrowing net of tax as discount rate. If it is Bank financing Vs. Lease financing qutstion You can use another alternative also but above is best alternative. - use cost of capital (the given cost of capital is always net of tax unless otherwise stated Hence no need to do net of tax) if it is Cash purchase Vs. Lease financing For Lessor. Always use Cost of capital as discount rate. no need to do net of tax because cost of capital itself is post tax (remember calculation of WACC.) |
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Lease is an alternative to borrow and purchase,it's have similar risk as that of borrow and purchase option ,so it's better to use post tax kd as discounting factor,some times we may an option to finance the asset with debt and equity ,such a case use KO as discounting factor,some times a firm may finance similar asset with debt and equity which it consider as optimal structure may consider KO as opportunity cost,so we can u ko or post kd as discounting factor,it's advisable to post tax kd as discounting factor,since leasing is alternative to borrowing
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