1. Lecture 5 Buy or Lease 課程重點 再看一個投資方案的評估 Buy or lease –The financing decision –A lease is a debt –with tax –using a risk-adjusted discount rate –Risk considerations –Lease with uncertain lives –The rate of discount –Leverage lease

2. The Baldwin Company: an example

6. Buy or lease: the financing decision An example: The acquired equipment costs $100,000. We can borrow the $100,000 at a cost of 5% per year, or we can lease the equipment at a cost of $29,000 per year. Assuming the equipment has an expected life of four years.

7. Approach 1: Buy: Annual payment = $28,201 Lease: $29,000 Lease is better??? Approach 2: Buy: PV=$10,000 Lease: PV=29000*B(4,0.05)=29000*3.5460=102,834 Buy is better.

8. Approach 3: Buy: cost=5% Lease: the implicit interest cost of leasing 29000*B(4,k)=100,000, k=0.062 Buy is better. Conclusion: With annual lease payment of $29,000 per year, there is a financial disadvantage to leasing, because the present value of the lease payment at 5% is larger than the amount that would have to be borrowed to finance the purchase through borrowing. If the lease payment required were less than $28,201, the lease would have a financial advantage.

9. A lease is a debt A question Assuming the firm normally uses a 0.1 weighted average cost of capital to evaluate investments, and the asset will earn cash flow benefits of $31,000 per year. Approach 1: Buy: NPV=31000B(4,0.1)-100,000=-1,733 Lease: NPV=(31000-29000)B(4,0.1)=6340 Lease is better???

10. Approach 2: debt is included in the cash flow. Buy: NPV=(31000-28201)B(4,0.1)=8873 Lease: NPV=(31000-29000)B(4,0.1)=6340 Approach 3:to compute the NPV using the cost of debt Buy: NPV=31000B(4,0.05)-100000=9923 Lease: NPV=(31000-29000)B(4,0.05)=7092

11. With taxes Condition 1: use the after-tax borrowing rate as the discount rate tax rate=0.4 Buy: NPV=0 A different repayment schedule would lead to a different pattern of after-tax cash flows. If we subtract the present value of the positive cash flows associated with borrowing (+100,000) from the present value of the after- tax cash payments (-100,000), NPV=0 Lease :NPV=((1-0.4)*29000)B(4, 0.05*(1-0.4))= =17400*3.7171=64677 Lease is better???

12. Condition 2: Considering depreciation With a tax rate of 40%, each dollar of depreciation expense for tax purpose will save $40 of taxes. Depreciation=$25,000, tax saving=0.4*25,000=10,000 Buy: 10000*B(4,0.3)=37171, 100,000-37171=62,829 Lease=64677 Buy is better. If a more rapid method of depreciation were used, there would be a more clearly defined advantage in favor of buying.