Lease Evaluation

Lease Evaluation

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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

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Models for Evaluation • Debt includes Lease • Investments are funded with a mix of debt, equity & lease • Weingartner’s Model

• Lease is a substitute to debt • Equivalent Loan Model • Bower-HerringerWilliamson 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

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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 – 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

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THE END

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