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Lease Evaluation

This document discusses various models for evaluating lease agreements from the perspective of a lessee: 1) Weingartner's model compares the net present value of buying an asset versus leasing it. It uses the marginal cost of capital as the discount rate. 2) The equivalent loan model treats the lease as a substitute for debt financing. It uses the marginal cost of debt as the discount rate. 3) The Bower-Herringer-Williamson model separately evaluates the financing and operating aspects of a lease. It compares the results to borrowing and buying. 4) The Bower model compares the present value of lease costs to the present value of ownership costs, using different discount rates

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4K views

Lease Evaluation

This document discusses various models for evaluating lease agreements from the perspective of a lessee: 1) Weingartner's model compares the net present value of buying an asset versus leasing it. It uses the marginal cost of capital as the discount rate. 2) The equivalent loan model treats the lease as a substitute for debt financing. It uses the marginal cost of debt as the discount rate. 3) The Bower-Herringer-Williamson model separately evaluates the financing and operating aspects of a lease. It compares the results to borrowing and buying. 4) The Bower model compares the present value of lease costs to the present value of ownership costs, using different discount rates

Uploaded by

api-3741610
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Lease Evaluation

1
Basic Mathematics
• Use of
• PVIF/ PVIFA
• Type of Annuity
• Regular Annuity (PVIFA) Vs Annuity-Due (PVIFA)
• Regular Annuity PV = A * PVIFA (i,n)
• Annuity Due = A + A* PVIFA (i, n-1)
• Flat Rate Vs Effective Rate of Interest
• Effective Rate = 2F{n/(n+1)}

2
PV of Annuity payable at interval
less than a year
• Lease quotes
Lease Term Rate
3 years 36PTPM (Arrear)
5 years 25PTPM (Advance)
Marginal Cost of Debt = 16%
PV (3 Years) = (36*12) * PVIFA 12(16%,3)
= 432 * i/i^12 * PVIFA (16%,3)
=432 * 1.0714 * 2.246 = 1039.549

PV (5 Years) = (25*12) * PVIFA 12 (16%,5)


= 300 * i/d^12 * PVIFA (16%,5)
= 300 * 1.0847 * 3.274 = 1065.392

3
Lease Evaluation - Lessee
• Financial
• Non- Financial Factors
– Simple documentation
– Expeditious sanction
– Post sanction reporting
– Flexibility
– Financial Position/Experience of Lessor

4
Models for Evaluation
• Debt includes Lease • Lease is a substitute
to debt
• Investments are
funded with a mix of • Equivalent Loan
debt, equity & lease Model
• Bower-Herringer-
• Weingartner’s Model Williamson
Model(BHW)
• Bower Model

5
Weingartner’s Model
• Leasing and buying as two ways of investing in
an asset
• Evaluate lease as an Investment alternative
– Lease if NPV(L) > NPV(B) > 0
– Buy if NPV (B) > NPV (L) > 0
• Discount Rate – Marginal Cost of Capital
• K = D/(D+E) x kD(1-T) + E/(D+E) x kE

6
Weingartner’s Model
• NPV (B) = - Initial Investment + PV of EBDIT x (1-T) +
PV (Tax Shield of Depreciation) + PV of Net salvage
Value
• NPV (L) = -PV of Lease Rental + PV of EBDIT x (1-T) +
PV (tax Shield on Lease Rentals) – Management Fee +
PV (Tax Shield on Management Fee)
• NAL = NPL – NPV = Initial Investment - PV (Tax Shield
of Depreciation) - PV of Net salvage Value - PV of Lease
Rental + PV (tax Shield on Lease Rentals) –
Management Fee + PV (Tax Shield on Management
Fee)

7
Equivalent Loan Model
• The decision to invest has already been made
• Asset will be debt financed
• Lease is a substitute to debt
• Discount rate = Marginal Cost of Debt
• Net value of lease = Initial Investment - PV (Tax Shield
of Depreciation) - PV of Net salvage Value - PV of Lease
Rental + PV (tax Shield on Lease Rentals) –
Management Fee + PV (Tax Shield on Management
Fee) – PV (Interest tax shield on displaced debt
• Amount borrowed = PV of Lease payment
8
Bower-Herringer-Williamson (BHW)
• Cash Flow Stream – Financing & Operating
• FAL = PV of Loan Payment – P.V. of Lease
Payments
• OAL = PV of Lease Related tax Shield – PV of
loan related tax shields – PV of Residual Value
• If FAL+OAL > 0 -Lease
• If FAL + OAL < 0 - Borrow and Buy
• Discount Rate
• PV of Lease Payment – pre-tax marginal cost of debt
• OAL – post tax marginal cost of capital
• Amount Borrowed = Cost of Asset
9
Bower Model
• COP = Initial Investment - PV (Tax Shield of
Depreciation) - PV of Net salvage Value
• COL = PV of Lease Rental - PV (tax Shield on Lease
Rentals) + PV (Tax Shield on Interest)
• Decision
• COL<COP – Lease
• COL > COP – Buy
• Discount Rate
• Tax Shields - unspecified rates
• Net salvage value – marginal cost of capital
• Lease Rental – pre-tax cost of debt
• Amount borrowed = Cost of Asset
10
Suggested Framework
• NAL= Initial Investment - PV (Tax Shield of Depreciation)
- PV of Net salvage Value - PV of Lease Rental + PV
(tax Shield on Lease Rentals) – Management Fee + PV
(Tax Shield on Management Fee) – PV (Interest tax
shield on displaced debt
• Amount borrowed = PV of Lease payment
• Discount Rate
• PV of Lease Payment – pre-tax marginal cost of
debt
• Tax shield/salvage value – marginal cost of capital

11
Break Even Lease Rental
• Point of indifference between lease and
buy
• NAL = 0
• If LRBEP > LR – Accept

12
THE END

13

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