LEASE OR BUY DECISIONS

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INTRODUCTION
In recent years, leasing has become a popular source of financing in India. From the lessee's point of view, leasing has an attraction of eliminating immediate cash outflows, and the lease rentals can be claimed as expenditure against the business income. On the other hand, buying has the advantage of depreciation allowance and interest on borrowed capital being tax deductible. Thus, an evaluation of the two alternatives is to be made in order to take a decision.

ILLUSTRATION
An asset costing 1,00,000 is to be acquired. There are two alternatives available to the entrepreneur. First one is Buying the asset by taking a loan of 1,00,000 repayable in five equal installments of 20,000 each along with interest @14% p.a. assuming that lease rentals, processing fees, interest as well as the principal amount are payable at the year end. The Second option is leasing the asset for which annual lease rental is 30,000 up to five years. The lessor charges 1% as processing fees in the first year. Assume the internal rate of return to be 10% and the present value factor at 10% is:

CONTD
YEARS 1 2 3 4 5 PV Factor .909 .826 .751 .683 .621

Suggest Which alternative is better in the above case. Assume the tax rate to be 30.9 % and rate of depreciation is @15%

BUYING THE ASSET

SI NO. Particulars
Loan repayment

2
11,200 31,200 12,750 23,950 7,401 23,799 0.826

3
20,000 8,400 28,400 10,838 19,238 5,945 22,455 0.751

4
20,000 5,600 25,600 9,212 14,812 4,577 21,023 0.683

5
20,000 2,800 22,800 7,830 10,630 3,285 19,515 0.621

1. 2. 3. 4. 5. 6. 7. 8. 9.

20,000 20,000

Interest @14% p.a. 14,000

Cash Outflow ( 1+2) 34,000

Depreciation@15% 15,000 on WDV Total of (2) and (4)

29,000 8,961 25,039 0.909

Tax Rate @30.9%

Adjusted Cash Outflow ( 3-6) P.V. Factor@10%

Present Value of adjusted cash outflow ( 7*8)

22,760

19,658

16,684

14,359

12,119

CONTD..
Therefore, the total net present value of cash outflows is 85,760.

LEASING THE ASSET

SI NO. Particular s

2
30,000

3
30,000

4
30,000

5
30,000

1. 2. 3. 4. 5. 6. 7.

Lease Rentals 30,000 Processing Fees Cash Outflow ( 1+2) Tax Rate @30.9%

1,000 31,000

30,000

30,000

30,000

30,000

9,579

9,270 20,730

9,270 20,730

9,270 20,730

9,270 20,730

Adjusted Cash 21,421 Outflow (3-4)

P.V. Factor@10%

.909

.826 17,123

.751 15,568

.683 14,159

.621 12,873

Present Value 19,472 of adjusted Cash outflow ( 5*6)

CONTD

Therefore, total net present value of cash outflows = 79,195 . Hence in the present case, lease finance works out to be cheaper than term loan.

THANK YOU