Here, candidates were asked to evaluate whether a company should use leasing or borrowing as a source of finance, explaining the evaluation method used. Many candidates struggled to score good marks here.

In explaining the evaluation method used, candidates should have said that selecting the least-cost financing choice required comparing the present value of the cost of leasing with the present value of the cost of borrowing to buy. These present values were calculated using the cost of borrowing as the discount rate, on a before-tax basis as the question said that taxation must be ignored.

The cost of borrowing was the correct discount rate as the evaluation was comparing borrowing with leasing. Interest payments were not a relevant cash flow to include in the evaluation, as the cost of borrowing was being used as the discount rate.

While this is the evaluation method covered in the F9 Study Texts, a significant number of candidates did not appear to be aware of it. Some candidates, for example, simply added up the cash flows relating to leasing and borrowing over the operating life of the asset, ignoring both the time value of money and the differences between the amount and timing of the cash flows under the two financing methods.

Calculation errors made by candidates included incorrect timing of the lease rental payments, assuming a discount rate other than the cost of borrowing, including six rather than five lease rental payments, including interest payments, and omitting the purchase cost.