New SIDBI Grade A New Batch Starts on Nov 18

    Register

    Question

    A company is in need of a new plant to ramp up production at its manufacturing unit. It is contemplating ways to finance the new plant and is deciding between debt or lease financing. How can it analyze the two options to decide which one would be preferable?

    A compare the payback periods for each alternative Correct Answer Incorrect Answer
    B compare the effective interest costs involved for each alternative Correct Answer Incorrect Answer
    C compare the net present values under each alternative, using the cost of capital as the discount rate Correct Answer Incorrect Answer
    D compare the net present values under each alternative, using the after-tax cost of borrowing as the discount rate Correct Answer Incorrect Answer
    E C or D depending on which discount rate is higher Correct Answer Incorrect Answer

    Solution

    Since both options are tax-deductible, the after-tax cost of borrowing is used to discount the cash flows under each alternative to find the NPV. The option with a higher NPV can be chosen by the company to finance its new plant.

    Practice Next

    Relevant for Exams: