Lecture 5: Leasing vs Buying

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Lecture 5 Leasing vs Buying

• Topic
• Ownership and control
• How to compare the total costs of leasing vs.
  buying?

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FT - Schedule (Midterm)
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PT Schedule (midterm)
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Asset Ownership Leasing

• Terminology
• Lessee User of a leased asset.
• Lessor Owner of a leased asset.
• Who controls the unspecified use of the machine?
  Owners have control rights in unforeseeable
  circumstances.
• Tax Treatment
• Lease rentals are allowable tax deduction for
  lessees in general.
• The lessor can claim depreciation on the leased
  asset.
• Depreciation reduces taxable income, providing an
  annual tax shield equal to depreciation tax
  rate.

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Lease vs. Purchase

• From lessees point of view, it is simply to use
  the NPV to evaluate two options.
• Total Cost of Leasing PV (Rentals) - PV(Rental
  tax deductions)
• Total Cost of Buying Cost of Purchase
  -PV(depreciation tax shield) - PV(after tax
  salvage value)

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An Example

• A new computer costs 300,000 (at t0). If you
  lease, you have to pay six rentals of 65,000
  each, payable annually in advance. The computer
  can be depreciated over 3 years on a straight
  line basis, and the disposal value is expected to
  be 10,000 at the end of the lease (t 6). The
  tax rate is 30, and the after-tax discount rate
  is 7.5. Should you lease or buy?

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PV (cost of buying)

• You pay 300,000 now
• You enjoy the tax benefit of depreciation from
  year 1 to 3. The amount of depreciation is
  100,000 per year.
• The PV of (after-tax) salvage value
• The total cost 300000 78016 - 4536 217,448

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PV (cost of leasing)

• Note the first payment occurs at t 0.
• Because the PV of the total cost of buying is
  lower, you should buy.