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(c) Comparison of 2 methods of finance
For the financing decision cash flows should be discounted at the after-tax cost of borrowing,
which is at 13% × 70% = 9.1%, say 9%
The present value (PV) of purchase costs

The PV of leasing costs
It is assumed that tax payments are fully tax-allowable

Using the above calculations Harrow would chose to lease the Excavator as it has a lower cost in
terms of NPV.
However, other matters should be considered:
1 Hire Purchase
No consideration appears to have been given to acquiring the excavator by using hire
purchase
2 Running expenses
The calculations assume that the running costs are the same under each alternative.
However expenses like maintenance, consumable stores, insurance and so on may differ
between the alternatives.
3 The effect on cash flow
Purchasing requires an immediate outflow of £300,000 compared to nothing for leasing.
This effect should be considered in relation to the company's liquidity position, which in
turn will affect its ability to discharge its debts and to pay dividends.
4 Alternative uses of funds
The proposed outlay of £300,000 for purchase should be considered in relation to
alternative investments given that Harrow is in a position of capital rationing.
5 Scrap value
The net present value of purchase is materially affected by the trade-in value of £60,000 in
the fifth year. This figure could be very inaccurate.
6 Other considerations
A disadvantage of the traditional approach to making a lease or buy decision is that if there
is a negative NPV when the operational cash flows of the project are discounted at the
firm's cost of capital, the investment will be rejected out of hand. However, the costs of
leasing might be so low that the project would be worthwhile provided the leasing option
were selected. This suggests that an investment opportunity should not be rejected without
first giving some thought to its financing costs.