Leasing Paradox

We previously looked at the lease versus buy decision from the perspective of the potential lessee, Tasha. We now turn things around and look at the lease from the perspective of the lessor, Johnson Leasing. The cash flows associated with the lease from Johnson's perspective are shown in Table 26.3. First, Johnson must buy the machine for $10,000, so there is a $10,000 outflow today. Next, Johnson depreciates the machine at a rate of $10,000/5 = $2,000 per year, so the depreciation tax shield is $2,000 X .34 = $680 each year. Finally, Johnson receives a lease payment of $2,500 each year, on which it pays taxes. The aftertax lease payment received is $1,650, and the total cash flow to Johnson is $2,330 per year.

What we see is that the cash flows to Johnson are exactly the opposite of the cash flows to Tasha. This makes perfect sense because Johnson and Tasha are the only parties to the transaction, and the lease is a zero-sum game. In other words, if the lease has a positive NPV to one party, it must have a negative NPV to the other. In our case, Johnson hopes that Tasha will do the deal because the NPV for Johnson would be + $87.68, the amount Tasha would lose.

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

VIII. Topics in Corporate Finance

26. Leasing

© The McGraw-Hill Companies, 2002

CHAPTER 26 Leasing

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