FINANCIAL MANAGEMENT (FIN202)

MR.WONG, BBA(Hons) (Fin), MBA (Fin)

Topic 12
(additional)
LEASING
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FORMAT: NET ADVANTAGE OF LEASING (NAL)

NAL = PV cost of leasing - PV cost of purchase

The net advantage to leasing (NAL) is the same thing

as the NPV of the incremental cash flows
If NAL > 0, the firm should lease
If NAL < 0, the firm should buy

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 Cash flow
(if don’t purchase asset)
Purchased asset
Tax on depreciation of
purchased asset
Maintenance cost saved
Tax on maintenance cost for
purchased asset
Tax on sale of purchased asset
(salvage value)
Cash flow (if leasing asset)
Lease payment
Tax on lease payment
Leasing expenses borne by
lessor
Tax on leasing expenses borne
by lessor
Leasing expenses borne by
lessee
Tax on leasing expenses borne
by lessee
Residual value (leased asset)
Tax on sales of leased asset
Year 0 Year 1 - 3 Year 4 (last year)
+
- -
+ +
- -
+
- -
If leasing are payable in - If leasing are not payable
advance in advance
+ +
If leasing are payable in + If leasing are not payable
advance in advance
+ +
If expenses are payable + If expenses are not
in advance payable in advance
- -
If expenses are payable - If expenses are not
in advance payable in advance
- -
If expenses are payable - If expenses are not
in advance payable in advance
+ +
If expenses are payable + If expenses are not
in advance payable in advance
-
+ 17-3
• *residual value is an estimation value after the
leasing period
• *salvage value is the purchased asset value after
fully depreciated
• *for the calculation of NPV, cost of debt (after tax)
which is cost of capital (after tax) is used
• cost of debt (after tax) or cost of capital (after tax)
= cost of debt (before tax) or cost of capital (before
tax) X (1 – tax rate)
• Tax on sales of leased asset
• = (residual value – salvage value) X tax rate

• Tax on sale of purchased asset

= salvage value X tax rate

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EXAMPLE (net advantage of Leasing @ NAL)
Alex, a sole proprietor, contemplating to purchase a
delivery van for $35,000. The depreciation is
$7,000 per year for 5-years, recorded at the end of
each year.
The van is estimated to have resale value of $4,000
by the end of 5th year. The purchase can be financed
at an effective lending rate of 10.5%.
Alternatively, the van can be leased for 5-year.
Annual lease payments would be $8,000 payable at
the start of each year, with a residual payment
obligation of $4,000.
Income tax rate is 40%.
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Cost of debt (after tax) = 10.5% (1 - 0.40) = 6.3%
Depreciation = $7,000
Tax on depreciation = $7,000 (0.40) = $2,800

Tax on maintenance cost (purchased asset)

= $0 (0.4) = $0

Tax on sale of purchased asset (salvage value)

= $4,000 (0.4) = $1,600

Tax on lease payment = 8,000 (0.4) = $3,200

Tax on sales of leased asset (residual value)

= (4,000 – 4,000) (0.40) = $0
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 Cash flow (if don’t purchase asset) Yr 0 Yr 1 - 4 Yr 5
Purchased asset +35,000
Tax on depreciation of purchased asset -2,800 -2,800
Maintenance cost saved 0 0
Tax on maintenance cost for purchased
asset 0 0
Tax on sale of purchased asset +1,600
Cash flow (if leasing asset)
Lease payment -8,000 -8,000
Tax on lease payment +3,200 +3,200
Leasing expenses borne by lessor 0 0 0
Tax on leasing expenses borne by lessor 0 0 0
Leasing expenses borne by lessee 0 0 0
Tax on leasing expenses borne by lessee 0 0 0
Residual value (leased asset) -4,000
Tax on sales of leased asset 0
NET CASH FLOW +30,200 -7,600 -5,200
PV ordinary annuity for Year 1-4 -26,154.90
PV of Year 5 -3,831.22
NPV +213.88
since NAL is positive with NPV of +213.88, then Alex should lease
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Adapted from:
•Principles of Managerial Finance, 14th edn, Pearson.
•Investopia.com

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