Asked by Lesley Figueroa on Jun 26, 2024
Verified
When calculating net present value earlier in the text, the appropriate cost of capital for a project was determined by the use of the funds, not the source. However, in leasing, we calculate the net advantage to leasing by discounting the cash flows at the lessee's after-tax borrowing rate. Aren't we violating our basic NPV principles here? Explain.
Net Present Value (NPV)
The difference between an investment’s market value and its cost.
After-Tax Borrowing Rate
The interest rate on borrowed funds after accounting for the effect of income taxes.
Cost of Capital
The rate of return that a company must earn on its investment projects to maintain its market value and attract funds.
- Comprehend the economic factors and calculations required for making decisions between leasing and purchasing.
Verified Answer
MA
Mahmoud AljohaniJun 30, 2024
Final Answer :
We use the after-tax borrowing rate because we are deciding which is better, leasing or buying and the risk of these financing cash flows is properly reflected in the firm's cost of debt. Essentially, we have assumed the decision to acquire the asset has already been made via other analysis.
Learning Objectives
- Comprehend the economic factors and calculations required for making decisions between leasing and purchasing.
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