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HOW NOT TO ANALYZE A LEASE

Asset cost
Interest rate
Lease rental payment
Annual depreciation
Tax rate

600,000
12%
140,000
100,000
40%

NPV(leasing)
NPV(buying)

386,801 <-- =-PV(B3,5,B4*(1-B6))+B4*(1-B6)

435,544 <-- =B2+PV(B3,6,B6*B5)

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EQUIVALENT LOAN METHOD

Asset cost
Interest rate
Lease rental payment
Annual depreciation
Tax rate

600,000
12%
140,000
100,000
40%

Year

After-tax cash flows from leasing

After-tax lease rental
-84,000

-84,000

-84,000

-84,000

-84,000

-84,000

After-tax cash flows from buying the asset

Asset cost
-600,000
Depreciation tax shield
Net cash from buying
-600,000

40,000
40,000

40,000
40,000

40,000
40,000

40,000
40,000

40,000
40,000

40,000
40,000

Differential cash flow: Lease saves lessor

Lease minus buy
516,000

-124,000

-124,000

-124,000

-124,000

-124,000

-40,000

IRR of differential cash flow

Decision??

8.30% <-- =IRR(B19:H19,0)

Buy

<-- =IF(B21<(1-B6)*B3,"Lease","Buy")

Split of loan repayment

between:

26
Year

Loan
Principal at
payment, end
beg. year
year

27
28
1
532,070
29
2
446,379
30
3
354,518
31
4
256,044
32
5
150,479
33
6
37,313
34
35 =NPV((1-$B$6)*$B$3,G28:$G$33)
36
=D28+B28-B29
37
38

149,539
145,426
141,017
136,290
131,223
41,791
=$B$3*B28

Interest

Repayment
of principal

63,848
53,565
42,542
30,725
18,057
4,478
=B28-B29

85,691
91,861
98,475
105,565
113,166
37,313

After-tax
loan
repayment
124,000
124,000
124,000
124,000
124,000
40,000

Lease minus
buy cash
flows, years
1-6
124,000
124,000
124,000
124,000
124,000
40,000

=(1-$B$6)*D28+E28

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THE LESSOR'S PROBLEM

Calculating the lowest acceptable lease rate
Asset cost
Interest rate
Lowest acceptable lease payment
Annual depreciation
Tax rate

600,000
12%
135,686 <-- Computed either with Goal Seek or Solver
100,000
40%

Year

Lessor after-tax cash flows from leasing

After-tax lease rental
81,412

81,412

81,412

81,412

81,412

81,412

Lessor after-tax cash flows from buying the asset

Asset cost
-600,000
Depreciation tax shield
Net cash from buying
-600,000

40,000
40,000

40,000
40,000

40,000
40,000

40,000
40,000

40,000
40,000

40,000
40,000

121,412

121,412

121,412

121,412

121,412

40,000

Lessor cash flows

Lease + buy
IRR of differential cash flow

-518,588

7.40% <-- =IRR(B19:H19,0)

Split of loan repayment

between:

24
Year
25
26
1
27
2
28
3
29
4
30
5
31
6
32
33 =NPV((1-$B$6)*$B$3,G28:$G$33)
34
35
36

Loan
Principal at
payment, end
beg. year
year
(521,513)
(437,651)
(347,750)
(251,377)
(148,064)
(37,313)

(146,444)
(142,419)
(138,104)
(133,478)
(128,519)
(41,791)
=$B$3*B28

=D28+B28-B29

Interest

Repayment
of principal

(62,582)
(52,518)
(41,730)
(30,165)
(17,768)
(4,478)
=B28-B29

(83,863)
(89,901)
(96,373)
(103,312)
(110,751)
(37,313)

After-tax
loan
repayment
(121,412)
(121,412)
(121,412)
(121,412)
(121,412)
(40,000)

Lease minus
buy cash
flows, years
1-6
(121,412)
(121,412)
(121,412)
(121,412)
(121,412)
(40,000)

=(1-$B$6)*D28+E28

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GREENVILLE ELECTRIC CORP.

Turbine cost
Greenville's borrowing rate
Lease payment

12,000,000
6.00%
2,300,000

Year
Lessee after-tax lease costs
After-tax lease rental

0
-2,300,000

Lessee after-tax purchase costs

Asset cost
Depreciation tax shield (Greenville Electric's tax rate = 0)
Net cash from buying
Cash saved by leasing
Lease - purchase cash flows
IRR of differential cash flow
Greenville's after-tax borrowing cost

-2,300,000

-2,300,000

-12,000,000

0
0

0
0

9,700,000

-2,300,000

-2,300,000

-12,000,000

5.96% <-- =IRR(B16:G16,0)

6.00% <-- =B3

UNITED TURBINE LEASING CORPORATION

Turbine cost
Lease payment
Depreciable life (years)
Depreciation (straight line, 3 years)
United Turbine's borrowing rate
United Turbine's corporate tax rate
Year
Lessor cash flows
Equipment cost
Lease payment, after tax
Depreciation tax shield
Total lessor cash flow
IRR of lessor cash flows
United Turbine's after-tax borrowing cost

12,000,000
2,300,000
3
4,000,000
6.00%
40%
0
-12,000,000
1,380,000
-10,620,000

1,380,000
1,600,000
2,980,000

1,380,000
1,600,000
2,980,000

3.86% <-- =IRR(B34:G34)

3.60% <-- =B26*(1-B27)

CORP.

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-2,300,000

-2,300,000

-2,300,000

0
0

0
0

0
0

-2,300,000

-2,300,000

-2,300,000

ORPORATION
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1,380,000
1,600,000
2,980,000

1,380,000
0
1,380,000

1,380,000
0
1,380,000

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RESIDUAL VALUES IN LEASE ANALYSIS

Asset cost
Interest rate
Lease rental payment
Annual depreciation
Tax rate
Residual value
Year

600,000
12%
140,000
100,000
40%
100,000 <-- Anticipated to be realized in year 7; fully taxed
0

After-tax cash flows from leasing

After-tax lease rental
-84,000
After-tax cash flows from buying the asset
Asset cost
-600,000
Depreciation tax shield
After-tax residual
Net cash from buying
-600,000

-84,000

-84,000

-84,000

-84,000

-84,000

40,000

40,000

40,000

40,000

40,000

40,000

40,000

40,000

40,000

40,000

40,000

40,000

60,000
60,000

-124,000

-124,000

-124,000

-124,000

-124,000

-40,000

-60,000

Differential cash flow

Lease minus buy

516,000

IRR of differential cash flow

10.49% <-- =IRR(B21:I21,0)

Decision??

Buy

<-- =IF(B23<(1-B6)*B3,"Lease","Buy")

UN-3B

RESIDUAL VALUES IN LEASE ANALYSIS

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Estimated residual value multiplied by certainty-equivalence factor which represents

uncertainty about realizing residual
Asset cost
Interest rate
Lease rental payment
Annual depreciation
Tax rate
Residual value
Certainty-equivalence factor
Year

600,000
12%
140,000
100,000
40%
100,000 <-- Anticipated to be realized in year 7; fully taxed
0.70
0

After-tax cash flows from leasing

After-tax lease rental
-84,000
After-tax cash flows from buying the asset
Asset cost
-600,000
Depreciation tax shield
After-tax residual
Net cash from buying
-600,000
Differential cash flow
Lease minus buy
IRR of differential cash flow
Decision??

516,000

-84,000

-84,000

-84,000

-84,000

-84,000

40,000

40,000

40,000

40,000

40,000

40,000

40,000

40,000

40,000

40,000

40,000

40,000

-124,000

-124,000

-124,000

-124,000

-124,000

-40,000

9.88% <-- =IRR(B22:I22,0)

Buy

<-- =IF(B24<(1-B6)*B3,"Lease","Buy")

42,000 <-- =(1-B6)*B7*B8

42,000

-42,000