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Sfm - leasing

Vivek Falod (Chartered Accountant (AIR)) (463 Points)

25 March 2014

Can someone please guide as to what rates are to be used fir discounting what cash flows in a leasing question..

There are three rates in the question:

1. Pre tax cost of debt

2. Post tax cost of debt

3. WACC / COC (post tax)

i need the logic n reasoning behind the application of what rate to what cash flow item.

please refer illustration 1 and illustration 7 of the study material before answering my question.

https://220.227.161.86/19346sm_sfm_finalnew_cp3.pdf

Thanks!

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5 Replies

nikhil (ca final) (233 Points)
Replied 25 March 2014

Dere r 2 types in leasing prblms, first one is from lessee's point of view... If asset is substantially financed by debt den use post tax cost of debt as discouting factor Nd if asset is financed by own funds den use wacc as discouting factor Nd 2nd one is from lessor's point of view... In such case wacc is used as discounting factor... Que 1 relates to first type so post tax cost of debt is used nd 7 is from another thus wacc is used.

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Vivek Falod (Chartered Accountant (AIR)) (463 Points)
Replied 25 March 2014

Sorry, I meant illustration 6 and not ill 7. Both questions are from lessee's point of view.

Here's a summary below on the rates used in both questions:

	Illustration 1	Illustration 6
	Pg 3.5	Pg 3.17
Point of view	Lessee	Lessee
Lease rental	Pre tax rate (Refer conclusion and not working note)	Pre-tax rate
Tax sheild of lease rent	Post tax rate	Pre-tax rate
Annual Payment	Pre- tax rate	Pre- tax rate
Depreciation	Post tax rate	Post tax rate
Interest tax sheild	Post tax rate	Post tax rate
Salvage	Post tax rate	Post tax rate

Also, there is some write up on this on pg 3.5 which I am unable to unserstand and which doesnt quite flow with the solution to illustration 6.

CA Sourabh Baser (Chartered Accountant) (115 Points)
Replied 27 March 2014

Always use post tax cost of debt in case of lessee as it is a financing decision....cost of cap cn b used only if it is specifically mentioned or when post tax cost of debt cannot be calculated ( source : j b gupta sir's book )