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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
Year 0 Year 1 - 3 Year 4 (last year)
(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 If leasing are payable in - If leasing are not payable
advance in advance
+ +
Tax on lease payment If leasing are payable in + If leasing are not payable
advance in advance
Leasing expenses borne by + +
lessor If expenses are payable + If expenses are not
in advance payable in advance
Tax on leasing expenses borne - -
by lessor If expenses are payable - If expenses are not
in advance payable in advance
Leasing expenses borne by - -
lessee If expenses are payable - If expenses are not
in advance payable in advance
Tax on leasing expenses borne + +
by lessee If expenses are payable + If expenses are not
in advance payable in advance
Residual value (leased asset) -
Tax on sales of leased asset + 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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