Misconception

In our lease versus buy analysis, it looks as though we ignored the fact that if Tasha borrows the $10,000 to buy the machine, it will have to repay the money with interest. In

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

Work the Web

A major financial decision for many of you will be whether to buy or lease a new car. We went to www.kiplinger.com and looked under the "More calculators" link to find a lease versus buy calculator. We analyzed a new car purchased for $28,500 on a 60-month loan at 6.9 percent and a $2,000 down payment. To lease the same car for three years requires a $500 monthly payment with a $1,500 upfront payment and a $1,000 security deposit. We assumed that the depreciation on the car would be average. Below you will see the information we entered.

And the results? Here they are:

As you can see, in this example, the better choice financially is to buy the car since it will cost $5,854 per year compared to the $6,183 annual cost if you lease.

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

VIII. Topics in Corporate Finance

26. Leasing

© The McGraw-Hill Companies, 2002

PART EIGHT Topics in Corporate Finance fact, we reasoned that if Tasha leased the machine, it would be better off by $10,000 today because it wouldn't have to pay for the machine. It is tempting to argue that if Tasha borrowed the money, it wouldn't have to come up with the $10,000. Instead, Tasha would make a series of principal and interest payments over the next five years. This observation is true, but not particularly relevant. The reason is that if Tasha borrows $10,000 at an aftertax cost of 5 percent, the present value of the aftertax loan payments is simply $10,000, no matter what the repayment schedule is (assuming that the loan is fully amortized). Thus, we could write down the aftertax loan repayments and work with these, but it would just be extra work for no gain, assuming the lessee is currently paying taxes (see Problem 10 at the end of the chapter for an example).

EXAMPLE 26.1 |

Lease Evaluation

In our Tasha Corp. example, suppose Tasha is able to negotiate a lease payment of $2,000 per year. What would be the NPV of the lease in this case?

With this new lease payment, the aftertax lease payment would be $2,000 x (1 - .34) = $1,320, which is $1,650 - 1,320 = $330 less than before. Referring back to Table 26.2, note that the aftertax cash flows would be -$2,000 instead of -$2,330. At 5 percent, the NPV would be:

Thus, the lease is very attractive.

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