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Leasing Decision

Parties to Lease Agreement:

There are two parties under any lease agreement:-

Lessor: – Owner of the asset is known as Lessor.

Lessee: – The party who uses the asset is known as Lessee.

Calculation of Equated Annual Install

When question specifies that loan is payable in Equal Installment then EAI should be calculated.

EAI = (Principle Amount)/PVAF(Interest  Rate, No. of Years)

Note: – Discount Rate or Interest for Calculation of EAI = Interest Rate on Loan amount without taking any effect of Tax on it.

Tax Shield on Expenses done at zero period will be taken during first year (Leasing Topic Only).

Present Value Factor of Annuity when Inflow/Outflow is at beginning of Year then

PVAF(r,n) = PVAF[r, (n-1)] + 1

Calculation of Lease Rent

When a leasing company desires a certain percentage on gross value of assets then,

Lease Rent = (Cost of Assets)/Annuity factor at rate desire of leasing co.

When Value of Machine and other Expenses given then,

Lease Rent = [PV of Cash Out Flow – PV of Inflow (Tax Shield on Depreciation/Expenses)]/Annuity Factor at Interest Rate

Salvage Value is deducted only when question specifies the method of depreciation as SLM.

Steps to Take Decision Whether Buy or at Assets on Lease by Lessee Point of view

Step I: – Calculate PV of Cash Outflow if Assets by Funding from Loan.

Step II: – Calculate PV of Cash Outflow if Assets is taken on Lease.

Step III: – Comparing PV Cash Outflow in both cases.

Step IV: – Decision: – Option which has lower Cash Outflow should be chosen.

Note: – Any Expenses which is common in both cases then those expenses is irrelevant for decision making.

Steps to take Decision whether Assets should be leased out or not by Lessor Point of view

Step I: – Calculate PV of Cash Inflow (After Tax Lease Rent).

Step II: – Calculate PV of Cash Outflow (Initial Cash Outflow and Recurring Expenses)

Step III: – Calculate NPV (PV of Cash Inflow – PV of Cash Outflow).

Step IV: – Decision: – If NPV is positive then Assets should be leased out otherwise not.

Step to decision for which option to choose for Sale and Buy Back Case     

Step I: – Calculate NPV at each option.

Step II: – Compare NPV at each options.

Step III: – Decision: – Option which has Highest NPV should be chosen. 

Discount Rate to be used:

For Lessee: – Kd(1 – Tax Rate)

For Lessor: – Weighted Average Cost of Capital.

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