Lease or Buy? 22.5 LO4 The company needs to determine whether it is better off borrowing the money and buying the asset or leasing Compute the NPV of the.

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Presentation transcript:

Lease or Buy? 22.5 LO4 The company needs to determine whether it is better off borrowing the money and buying the asset or leasing Compute the NPV of the incremental cash flows Appropriate discount rate is the after-tax cost of debt since a lease is essentially the same risk as a company’s debt

Net Advantage to Leasing LO4 The net advantage to leasing (NAL) is the same thing as the NPV of the incremental cash flows NAL = Investment – PV(after-tax lease payments) – PVCCATS – PV(Salvage) If NAL > 0, the firm should lease If NAL < 0, the firm should buy

Example – continued LO4 Consider the previous example. Assume the firm’s cost of debt is 11%. After-tax cost of debt = 10(1 - .4) = 6.6% NAL = -119 Should the firm buy or lease?