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Sfm leasing doubt

23 September 2016

Dear friends, I am referring sd bala sirs book for sfm. While studying lease as per sd bala sirs books cash flows are discounted at after tax cost of debt and hence interest on debt is ignored. But as per PM, pr.8 is solved using after tax costof debt but still interest on debt is deducted. I'm really confused. Please guide me. Thanks

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6 Replies

NISHA AGARWAL (Chartered Accountant) (454 Points)
Replied 24 September 2016

it must be tax advantage on interest on debt and not interest on debt.

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CA Ajay Thakkar (Others) (148 Points)
Replied 24 September 2016

INTEREST ARE ALWAYS DEDUCTED TO FIND NET CASHINFLOW. TO FIND PV OF CASHINFLOW WE HAVE TO CONSIDER RATE OF COST OF FUNDS APPLICABLE TO THE COMPANY. SAY RATE OF INTEREST TO COMPANY IS 10% BUT SINCE INTEREST IS TAX DEDUCTIBLE , THE NET COST OF FUND TO THE COMPANY IS 10 - 3 (TAX @ 30%) = 7%. SO CASHINFLOW ARE DISCOUNTED AT 7% AND NOT AT 10%.

FURTHER WE ALWAYS TAKE WACC TO COMPANY (COST OF EQUITY + COST OF DEBT) FOR DISCOUNT PURPOSE.

COST OF EQUITY WEIGHT

12% 40%

7% 60%

WACC = 12% X 0.4 + 7% X 0.6= 9%

RATE OF DISCOUNT = 9%

CA Ajay Thakkar (Others) (148 Points)
Replied 24 September 2016

INTEREST ARE ALWAYS DEDUCTED TO FIND NET CASHINFLOW. TO FIND PV OF CASHINFLOW WE HAVE TO CONSIDER RATE OF COST OF FUNDS APPLICABLE TO THE COMPANY. SAY RATE OF INTEREST TO COMPANY IS 10% BUT SINCE INTEREST IS TAX DEDUCTIBLE , THE NET COST OF FUND TO THE COMPANY IS 10 - 3 (TAX @ 30%) = 7%. SO CASHINFLOW ARE DISCOUNTED AT 7% AND NOT AT 10%.

FURTHER WE ALWAYS TAKE WACC TO COMPANY (COST OF EQUITY + COST OF DEBT) FOR DISCOUNT PURPOSE. COST WEIGHT

EQUITY 12% 40%

DEBT 7% 60%

WACC = 12% X 0.4 + 7% X 0.6

= 9%

RATE OF DISCOUNT = 9%

shobhana ranjan (asasgs) (102 Points)
Replied 24 September 2016

Thanks for the clarifications

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sandeep (student) (206 Points)
Replied 27 September 2016

If you refer RTP Nov 2015,similar kind of adjustment is there.In that problem they took after tax cost of debt and ignored tax savings on interest.But in PM Q8,it is the other way.

These are the cases where we get confused about what is correct and what is not.Simply do in both possible ways in exam by referring to a note.