Answer: $740,000 (negative NPV of buy option)Under CIMA F3’s lease-or-buy framework, the buy option is evaluated by discounting the after-tax cash flows associated with owning the asset. When an asset is purchased, the immediate cash outflow is the purchase price, but ownership provides a benefit through tax-allowable depreciation, which creates an annual tax shield (a reduction in tax payable). Because corporate tax is paid in the same year that profit is earned, the depreciation tax shield arises each year from Year 1 to Year 5.Step 1: Initial cost (Year 0 outflow)Asset cost = $1,000,000 (cash outflow at time 0).Step 2: Annual tax depreciation and tax shieldStraight-line over 5 years, no residual value:Depreciation = 1,000,000/5=200,0001{,}000{,}000 / 5 = 200{,}0001,000,000/5=200,000 per year.Tax shield each year = 200,000×30%=60,000200{,}000 \times 30\% = 60{,}000200,000×30%=60,000.Step 3: Discount rateCIMA F3 applies the after-tax cost of debt when valuing tax-deductible flows funded by borrowing:After-tax discount rate = 7.14%×(1−0.30)=4.998%≈5%7.14\% \times (1 - 0.30) = 4.998\% \approx 5\%7.14%×(1−0.30)=4.998%≈5%.Step 4: Present value of tax shields (5-year annuity at 5%)Annuity factor = 1−(1.05)−50.05=4.32948\frac{1 - (1.05)^{-5}}{0.05} = 4.329480.051−(1.05)−5=4.32948.PV of tax shields = 60,000×4.32948=259,76960{,}000 \times 4.32948 = 259{,}76960,000×4.32948=259,769.Step 5: NPV of buy optionNPV=−1,000,000+259,769=−740,231≈−740,000NPV = -1{,}000{,}000 + 259{,}769 = -740{,}231 \approx -740{,}000NPV=−1,000,000+259,769=−740,231≈−740,000 So the buy option has an NPV of approximately –$740,000 (nearest $000).Questions no: 198327
