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Equivalent load method of lease evaluation

DECISSION TO BUY OR LEASE

Asset cost

600,000

LESSE PROBLEM

Interest rate
Lease rental payment
Annual depreciation
Tax rate

12%
140,000
100,000
40%

Year
After-tax cash flows from leasing
After-tax lease rental

0
-84000

After-tax cash flows from buying the asset


Asset cost
Depreciation tax shield
Net cash from buying
Differential cash flow: Lease saves lessor
lease minus buy
IRR of differential cashflows
Decission

The Lessors Problem:


Calculating the Highest Acceptable Lease Rental
What is acceptable lease rental for lessor
Lessor PROBLEM

-600000
-600000
516000
8.30%
buy

Asset cost
Interest rate
Lease rental payment
Annual depreciation
Tax rate

Year
After-tax cash flows from leasing
After-tax lease rental

After-tax cash flows from buying the asset


Asset cost
Depreciation tax shield
Net cash from buying
Differential cash flow: Lease saves lessor
lease plus buy
IRR of differential cashflows

Minicase: When Is Leasing Pro table

600,000
12%
135,991
100,000
40%
0
81595

-600000
-600000
-518405
7.46%

for Both the Lessor and Lessee?

Turbine cost
Greenville's borrowing rate
Lease payment

10,000,000
6.00%
1,800,000

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

-1,800,000

-1800000

Lessee after-tax purchase costs


Asset cost
Depreciation tax shield (Greenville Electric's tax rate = 0)
Net cash from buying
lease-purchase cashflows
IRR

-10,000,000
-10,000,000
8200000
3%

0
0
-1800000

UNITED TURBINE LEASING CORPO


Turbine cost
Lease payment
Depreciation (straight line, 5 years)
United Turbine's borrowing rate
United Turbine's corporate tax rate
Year
Lease rental

If lessor want to buy


Asset cost
After tax shield
Total
lease+buy cashflow
IRR

Exercise
Q1 Part A
Asset cost
Depreciation 1-5 years
Rental payments
Tax rate
Cost of capital
Year

10,000,000
1,800,000
2,000,000
6.00%
40%
0
1080000

1
1080000

-10,000,000
800000
-10,000,000
800,000
-8,920,000 1,880,000
4.30%

1000000
200000
300000
40%
10%
0

Leasing
After tax leas rental

BUY
Cost
Tax shield
Total
Lease - Buy
IRR
Decision

-180000

-1000000
-1000000
820000
19.17%

80000
80000
-260000

BUY

Q1 Part B
Asset cost
Depreciation 1-5 years
Rental payments
Tax rate
Cost of capital

1000000
200000
299977.8689
40%
10%

Year
Leasing
After tax leas rental

BUY
Cost
Tax shield
Total
Lease +Buy
IRR
Decision

-180000

179986.7213 179986.72

-1000000
80000
-1000000
80000
-820013.2787 259986.72
19.16%
BUY

Muntazir Hussain

-84000

-84000

-84000

-84000

-84000

40000
40000

40000
40000

40000
40000

40000
40000

40000
40000

40000
40000

-124000

-124000

-124000

-124000

-124000

-40000

81595

81595

81595

81595

81595

40000
40000

40000
40000

40000
40000

40000
40000

40000
40000

40000
40000

121595

121595

121595

121595

121595

40000

or

GREENVILLE ELECTRIC CORPORATION

-1800000 -1800000 -1800000 -1800000

0
0
0
0
0
0
0
0
-1800000 -1800000 -1800000 -1800000

0
0
0

UNITED TURBINE LEASING CORPORATION

2
1080000

5
1080000

6
0

800000
800000
800000
800000
800,000 800,000 800,000 800,000
1,880,000 1,880,000 1,880,000 1,880,000

800000
800,000
800,000

3
1080000

4
1080000

-180000

-180000

-180000

-180000

80000
80000
-260000

80000
80000
-260000

80000
80000
-260000

80000
80000
-260000

80000
80000
-80000

179986.7 179986.7 179986.7 179986.7

80000
80000
80000
80000
80000
80000
80000
80000
259986.7 259986.7 259986.7 259986.7

80000
80000
80000