Leasing Decisions

Another area of economic decision-making a firm may face is the lease vs. buy or lease
vs. do-nothing analysis. If an asset in an investment proposal (or even the total proposal)
may be either purchased or leased, the investment evaluation must first be performed to
see if the asset should be acquired at all. This decision is based on the firm's hurdle rate
and other competing investment opportunities. If this analysis indicates that the asset
should be acquired, then the next step is to perform the lease vs. buy evaluation to
determine how the asset should be acquired, i.e., lease or purchase. The after-tax cash
flow associated with the lease should be determined and subtracted from the purchase
cash flow and the discount fate determined. (For simplicity, costs identical to each case
need not be included since the net effect is zero.) This will equate to the implicit interest
rate associated with the lease. The relevant criterion to judge this return is based on the
after-tax cost of corporate long-term debt. (Leases can be separated into categories, e.g.,
financing and operating, with separate debt rates set for each.)