Agricultural & Applied Economics Association

The Lease-Purchase Decision for Agricultural Assets

Author(s): Stephen A. Ford and Wesley N. Musser
Source: American Journal of Agricultural Economics, Vol. 76, No. 2 (May, 1994), pp. 277-
285
Published by: Oxford University Press on behalf of the Agricultural & Applied Economics
Association
Stable URL: http://www.jstor.org/stable/1243629
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 The Lease-Purchase Decision for
Agricultural Assets
Stephen A. Ford and Wesley N. Musser

The decision to lease or purchase an asset is analyzed with methodology adapted from
the corporate finance literature. The methodology allows determination of a break-
even lease payment using a minimum of information. Symmetry between the lessee
and lessor is also examined. Effects of changes in the discount rate, marginal tax rate,
capital rationing, and other parameters on break-even lease payments are examined
analytically and numerically. Analysis of differences in the parameters of the lessee
and lessor identifies conditions under which markets for leasing arrangements will
exist.

Key words: asset acquisition, capital rationing, leasing.

Evaluation of financial leases is a standardemphasizes symmetry in the decision frame-

work of the lessee and lessor and how
topic in farm financial management. Beginning
with Hopkin in 1971, the journal literature opportunities
in- for leasing assets arise wi
cludes Lins; Willet and Penland; LaDue; and ferences in parameters of the two econ
Robertson, Musser, and Tew. Agricultural agents.
fi-
nance texts also consider the decision to lease
or purchase assets (Barry, Hopkin, and Theoretical
Baker; Framework
Lee, Boehlje, Nelson, and Murray). Neverthe-
less, recent interest in this issue is limited,
The lease-purchase decision concerns optimal
perhaps because the Tax Reform Act of 1986 financing of an asset that capital budgeting has
greatly reduced the tax benefits of agriculturaldetermined to be a profitable investment. Previ-
asset ownership (Hanson and Bertelsen; ous research has evaluated lease-purchase
Carman). However, some innovations in the decisions by comparing the net present values
evaluation of financial leases have occurred in
of the cash flows associated with leasing and
the corporate finance literature. Levy and purchasing (Robertson, Musser, and Tew;
Sarnat (1979) developed a break-even frame- LaDue). The annual cash flow from an asset for
work which is much simpler than earlier a lessee can be written following Levy and Sarnat
methods in agricultural finance. This frame-(1979, 1990) as
work has been adopted in corporate finance
texts (Levy and Sarnat 1990; Copeland and
Weston). (1) (1 - 7) (St- C,- L)
Our paper adapts this break-even framework
where T is the marginal tax rate, St is gross rev-
to agricultural leases and demonstrates its uses
enue from the asset in year t, C, is variable
in evaluating such leases. An adapted basic costs of production in year t, and L, is the lease
model is derived and explained. The corporatepayment in year t. The annual cash flow for a
finance literature is extended to include salvage
purchase would be written as
value of purchased assets and owner mainte-
nance costs, and the model is used to analyze
the influences of discount rates, income tax (2) (1 - T) (St- Ct- M,- D,) + D,
rates, capital rationing, and other parameters on
where the variables are as for equation (1), M,
the break-even lease payment. An empirical ex-
is any additional maintenance required in year t
ample for tractor leases is then presented which
under the decision to buy, and D, is deprecia-
tion in year t. The sum of net present values of
The authors are assistant professor and professor of agricultural
economics, respectively, at the Pennsylvania State University. these annual cash flows and appropriate initial
Musser was a visiting professor at Purdue University when this re- and discounted terminal cash flows for the life
search was completed. of the lease of these two cases are then com-
The authors wish to acknowledge Beth Pride Ford, George F.
Patrick, and James W. Dunn for their helpful comments. pared in the standard agricultural finance
Review coordinated by Richard Adams. presentation.
Amer. J. Agr. Econ. 76 (May 1994): 277-285
Copyright 1994 American Agricultural Economics Association

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 278 May 1994 Amer. J. Agr. Econ.

Current models in the finance literature

evaluate the lease-purchase decision with the + (1- T)M, - TD, G, - TV,
net present value of the difference in the two ,=l [1 + (1- T)r]' [1+(1- t)r
cash flows. Since (1-T)(S,-C,) appears in both
where r is the before tax discount rate. If NPV
(1) and (2), this term is not in the difference,
which emphasizes the irrelevance of these < 0,costs
then the net cash outflows from leasing are
less than from purchasing, and leasing is more
and returns in the financing decision. Subtract-
ing equation (2) from equation (1), the profitable.
cash If NPV > 0, then purchasing the as-
set is
flow difference in year t of leasing instead of more profitable than leasing it.
purchasing the asset is Assuming that the lease payment is constant
over the life of the lease, Lt is time independent
and can be replaced with L. A break-even lease
(3) - [(1 - T)Lt + TD,] + (1 - T) Mt.
payment, L*, can then be calculated by setting
NPV fi-
Unlike assumptions made in the corporate = 0 and solving for

(7) TDt, (1-I-

T)Mt+I-
Gn - TVn

?-=1 [1+(1-_T)r]t r=1 [1++(1-T)r T)r]

n-1 (1 - T)
t=o [1+(1- T)r]t

nance literature, agricultural lease payments are L* is the lease payment, above (below) which
usually paid at the beginning of the year. Thus, the purchase (lease) of the asset would be more
L, in the terminal year of the lease, n, is zero. profitable. Dividing equation (7) by L* provides
In addition, the net cash flow from the salvage some intuition on the equation. The numerator
value of the purchased asset must be subtracted of this result is the sum of the incremental dis-
from equation (3) for year n counted cash outflows from purchasing the
asset. The denominator is the sum of incremen-
(4) - TD, + (1 - T)M, - (G, - TV,) tal discounted cash outflows from leasing,
which can be interpreted as a tax-adjusted
present value of an annuity formulation for
where Gn is the salvage value in year n and Vn
is the capital gain on the sale of the asset.lease
Vn payments.
can be expressed mathematically as The appropriate level of r in (7) requires
some modification from that in Levy and Sarnat
(1979). They use a nominal discount rate be-
cause the value of Dt and L* are fixed over the
(5) Vn = G- (Io - D,) t=1
life of the asset and lease. A nominal rate re-

flects the declining real value of Dt and L* over

where I0 is the initial purchase price of the as- the term of the lease. This logic seems appro-
set. Levy and Sarnat abstract from salvage priate in agricultural analyses. A corollary is
values; however, markets exist for many used that Mt and G, should be inflated to reflect the
assets leased in agriculture, so that these cash inflation rate embedded in r. Levy and Sarnat
flows are included in (4). recommend using the borrowing rate of the
The net present value of the difference be- firm as r. This choice is justified by cash flows
tween leasing and purchasing (NPV) is from Dt and L* being fixed and subject to simi-
calculated by adding the difference in initial
cash flows between purchasing and leasing,lar I0 risk
- as borrowing.
complicates this logic: Inclusion of M,
M, is subject to and
riskGn
in
L0, to the discounted cash flow advantage of
leasing over the duration of the lease (tis maintenance requirements
=subject to risk of the
in profitability asset,
of the and
asset Gn
due
1,...,n) to changes in demand for output or technologi-
cal obsolescence. Thus, the overall cash flows
n-1 (1- T)Lt for ownership in (7) are riskier than for borrow-
(6) NPV Io t=O
- T)r]t
[1+(1- T)r]t
ing. If this risk is similar to the overall business
risk of the firm, the weighted average cost of

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 Ford and Musser Lease-Purchase Decision 279

capital would be appropriate be written as in the num

of (7).
The fixed nature of L* is not changed with n-' (1- T)L
modifications to r. However, Levy and Sarnat's (9) NPV = -I0 + 1
t=o [1+(1I- T)r]t
reasoning here is questionable. A financial
lease involves a fixed commitment of cash out-
flows over the presumed life of the asset, which
n(1- T)M - TD G, - TV,
increases operating leverage similar to any
t=l [I + (I -T)r]t [I + (I 1- T)r]
fixed cash payment. In addition, the firm has a
long-term commitment to these payments evenThe break-even lease payment derived from
if the asset becomes technologically obsolete.
this analysis is

(10) TDt, (1- T)M, G, -TV,

l =1 [1+(1- T)r]n-1=1i[1+(1-T)r]t
(1- T) [ +(1- T)r
t=o [1+(1- T)r]t

In contrast, an owned asset may be replaced L* in equation (10) is the value of L at which
without continued cash outflows. Thus, more the lessor's desired return on the investment is
risk may exist with financial leasing than with attained. For L > L*, NPV > 0 for the lessor.
debt payments. If so, a higher value of r than Equation (10) is identical to equation (7).
the borrowing rate should also be used in the Myers, Dill, and Bautista; and Lewellen, Long,
denominator of (7). The analysis in this paper and McConnell also conclude that the break-
assumes similar risk from both methods of fi- even payments for the lessee and lessor would
nancing and uses a nominal weighted cost of be the same in efficient competitive markets
capital in subsequent simulations for both sets with the same parameter values. Note that the
of cash flows. This assumption may need to break-even
be lease payments are identical for the
modified with capital rationing, but discussion lessee and lessor, but only if they have the same
of this issue is deferred to a later section. discount and tax rates, are able to purchase the
A useful result of the Levy and Sarnat model asset at the same initial purchase price, and use
is that the lessor's lease-purchase decision isthe same depreciation schedule. Unlike the cor-
analogous to that of the lessee, and the result-porate case, all these parameters are typically
ing break-even lease payment is identical tonot identical for economic agents in agriculture.
that of the lessee. In this model, a lessor owns the Thus, the potential for profits from leasing as-
asset only for leasing purposes, not for produc- sets exists, as does the possibility of no leasing
tion. Thus, S, and C, are not relevant to the market for an asset due to divergence in the
lessor's decision. The lessor evaluates whether
break-even lease payments for the lessee and
lessor.
to purchase an asset for lease or to invest in an al-
ternative opportunity. The annual cash flow return Evaluating the lease-purchase decision as
in period t of the leased asset to the lessor is NPV of the cash flow advantage of leasing has
two useful features. First, because revenues and
(8) (1 - T) (L,- Mt- D,) + D, variable costs in the lease and the purchase
cash flows cancel (equation 3), a partial bud-
where all variables are as defined previously. Ingeting analysis of the decision does not require
year n, L, is zero and G,- TV, is added to equa-a complete accounting of all cash flows for
tion (8). both scenarios. Second, the analytical method
The analysis of the lessor's decision involves outlined above allows the calculation of the
the comparison of NPV of annual returns de- break-even lease payment with limited informa-
scribed above to the initial purchase cash tion in (7). Once calculated, the break-even
outflow of the asset, -I0 plus the initial lease lease payment can be compared to any contrac-
payment cash inflow, LO. The comparison can tual or informal leasing offers.

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 280 May 1994 Amer. J. Agr. Econ.

Sensitivity of the Break-even L

to Equation Parameters
It[
Limited investigation of the effec
tax and discount rates on lease analysis has
been conducted. Robertson, Musser, and Tew
simulated the effects of the tax rate and dis-
count rate on NPV of a lease arrangement for a 0[[l+(1-T)r]-t
The first and third terms of (11) are always
farmer or lessee. Their analysis suggests that
positive, and the second is always negative.
leasing is more profitable than purchase at
The sign of the fourth term, (I - ...), is ambigu-
lower tax rates and higher discount rates.
ous. The ratio in parentheses at the end of this
Myers, Dill, and Bautista also concluded that
term is positive for all parameters. The part of
assets will be leased by lessees with lower tax the term in brackets is the numerator of L* in
rates from lessors with higher tax rates. This
section examines the theoretical basis of the ef-
(7). Therefore, the fourth term will be positive
as long as the break-even lease payment is
fects of changing tax rates, discount rates, and
positive. When M, is zero for all t, as is com-
other parameters on break-even lease payments,
mon for financial leases, the second term of
followed by numerical analysis of the issue.
(11) is zero. Then, L* will increase with the dis-
The theoretical analysis is an extension of Levy
count rate for all situations when it is positive.
and Sarnat, who only derive the break-even for-
mula.
Thus, the sign of the partial derivative with re-
spect to the discount rate will be positive in
The effects of the different parameters on the
most practical cases.
break-even lease payment can be evaluated
Individual terms in equation (11) concern the
with the signs of the partial derivatives of the
effects of r on particular cash flows affecting
break-even lease payment with respect to each
L*. The first term is the effect of r on TD,. As r
variable. Using the product and chain rules,
changes, the after-tax discount rate changes in
equation (11) is the partial derivative of the the same direction, and the sum of the dis-
break-even lease payment with respect to the
discount rate
counted tax savings changes in the opposite
direction. Since the value of discounted tax
savings is inversely related to L*, the change in
discounted tax savings changes L* in the oppo
site direction, but in the same direction as the
change in r. Thus, a positive change in r caus
dr n-
d Y, [1+(1- T)r]-t'
a positive change in L*. In other words, a larger
t=0 discount rate causes the discounted tax benefits
of depreciation to be smaller so that a lessee
(lessor) will pay (have to be paid) a larger lease
(1- T)tM,[l +(1- T)r]-t-1 payment to break even. Similar logic exists
I-[I +(1- T)r]-t with respect to Mt whose decreased discounted
t=0
sum decreases L*, and the term (G,-TV,),
whose decreased discounted sum increases L*
in the second and third terms of the partial de-
n(GI - n-i
TVW,)[I+(1- T)r]-+-1 rivative. The final term concerns the
denominator of (7) and (10), which is th
-[1 +(1- T)r]-t
t=O
adjusted present value of an annuity i
factor associated with L*. As r increase
factor decreases, which increases L* because
the future values are discounted less. The effect
Io - TDt[1+(1- T)r]-t
n t
of individual parameters on L* is complex, and
+ simulation
Y(1 over only a few numerical values
could be misleading.
Equation (12) is the partial derivative of the
break-even lease payment with respect to the
-(Gn
marginal tax rate.

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 Ford and Musser Lease-Purchase Decision 281

due to change in the discount rate with nega-

n- n- XDJ[1+(1- tive and positive signs, respectively. The
T)r]t
positive fifth and negative sixth terms are the
effects of the tax rate change on discounted
(12)(1- T) [1+(1- t=0 T)r]-
taxes on the terminal capital gain. The final
o ( Trtl)+ [ 1+-(I_-T)r] term is the derivative of the denominator
holding the numerator constant and is impos-
sible to sign. Therefore, the sign of this
iZTrtD)[1
t=l

n-1_
+(1- T)r]-1 expression is indeterminate which is consis-
(1T)T),[I1+(1-T)r]
t=0
tent with Lewellen, Long, and McConnell.
Analysis of the effects of the tax rate on the
break-even lease payment therefore requires
SrtM,[1+ (1- T)r]-t numerical methods. Changes in T have com-
n-+ 1
plex effects on L* which suggest caution in
generalizing from numerical analysis.
(1- T),[I1 + (1- T)r]-t The partial derivative of L* with respect to
t=0

M, is presented in (13) and has a positive sign.

- rtM[1 + (1- T)r]-t-

+_ t=l n-1 (1- T)

- [1+(1-
S + (1- T)M(1 T)r]_
(1- T)r]-t
(13) dL* _L*
[ +(1-T)r
[l+(l-T)r]t
dMt n-1
I , (1- T)
Vn[1 + (1 - T)r]-n t=o [1 + (1- T)r]t
(1- T)X[1+(1-T)rft
n-1
(1- T)r[I +t=0 (1 - T) t[]-t + (1- T)r
Note, however, that if M, is constant over the
rn(G - TVn)[1+ (1- T)r]-) - life of the lease and equal to M, then the partial
t=0 n-1 derivative of L* with respect to M is less than
(1- T)[1+(1- T)r]-t one. This result is intuitive since the annual
t=0
lease payment in such a case changes by an
amount equal to the value of lessor-provided
To interpret (12), - T)ra positive change inputs, discounted to the beginning of the year
t=l
when lease payments are made.
A final parameter to evaluate is the initial in-
vestment, I0, which may be less for specialized
- +1 (1 - T)Mt[1 + (1- T)r]-t lessors of agricultural assets. Multiple asset
purchases result in discounts in the asset pur-
-(in T. The - T)[erm is + (- )r]ease in dis-
chase cost or savings in other transaction costs
and therefore a lower I0 than for an individua
farmer-lessee. The partial derivative of L* with
-1 [1 + (1- T)r]-' + I r(1- T)t[1+ (1- T)r]-t-1
=0increase in discounted tax savings from de- respect to 10 is

(1 - T)[1 + (1- T)r]-'

1X T T 1 - 1
1- t=1 +
dI, t=1dI
To interpret (12), assume a decreapositive change
in T. Thwere subtracted rmisrom the increase in dis-
(14) dL* [
d - (1- T)
lacousinted tax saderiving L, the effprect iationn forL is the
r=o [1 + (1- T)r]t

Note that dD/dIo > 0 with

opposite of purchasinged assets, and the second term igns arthe tion method. Also, the sum of annual
depreciations must be less than or equal to th
initial purchase price I0. These facts imply that
negative. Similarly, the third and fourth
terms are changes in tax savings from the
maintenance and the value of the tax savings
t = l "lo

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 282 May 1994 Amer. J. Agr. Econ.

Because 0 < T Table

< 1 and Tractor
1. Break-Even dD/dlo is
Lease Payments,
while 1 is not, r=8%
the second term of
than the first. Similar logic indic
third term of (14)
Term isTax positive.
rate Ther
always positive, and the break-eve
(Years) as
ment will increase 0% 15%the 28% 33%
initial p
increases.
1 $21,333 $21,573 $21,785 $21,868
A simulation program was written to calcu-
2 $11,718 $11,880 $12,023 $12,079
late the break-even lease payment given various
3 $8,519 $8,628 $8,724 $8,762
values of the key parameters-lease term in 4 $6,924 $6,991 $7,049 $7,072
years, discount rate, tax rate, initial investment,
5 $5,971 $6,002 $6,029 $6,039
and owner payment of costs. The break-even 6 $5,339 $5,338 $5,337 $5,335
lease payments for a tractor lease over a range 7 $4,890 $4,860 $4,831 $4,820
of tax rates and lease terms are presented in
table 1. These payments are calculated based on
a $38,000 initial purchase price, an $18,000
tical break-even lease payments if th
salvage value, an 8% discount rate, and a stan-
same parameters. However, the mark
dard 150% declining balance MACRS
characteristics of the lessee-lessor
depreciation schedule for a seven-year asset us-
will be quite different if parameters
ing the half-year convention and no expensing
parties are not identical.
(U.S. Internal Revenue Service). The break-
Several plausible scenarios could produce
even lease payments reflect the relationship of
different relationships between the lessor's and
the time value of money and the tax advantages
lessee's break-even lease payments. First, the
of leasing over purchasing the asset, as well as
the cash flow from the tractor sale at the end of
lessee's marginal tax rate may be lower than the
lessor's so that the former has a higher break-
the lease. In general, financial leasing becomes
even lease payment. If both the lessee and
less favorable relative to the purchase of the as- lessor have an 8% discount rate and the lessee's
set as the length of the lease increases, given a
marginal tax rate is 15% while the lessor's is
constant salvage value. However, the salvage
33%, the break-even lease payments for the les-
value of the tractor may be greater than
see and lessor would be points A and B in
$18,000 in the early years of the lease so that
figure 1, respectively. Since the lessee is will-
perhaps the break-even payments for leases of
ing to pay less than point A and the lessor
one to three years should be recalculated with a
would be willing to take more than point B, a
higher salvage value. The effect of the tax rate
mutually agreeable lease payment is impossible
on leases of six and seven years in duration is
in this case. The opposite case may occur given
opposite of that on leases of shorter lengths and
different depreciation, lease length, and salvage
is similar to that in Roberson, Musser, and Tew.
value assumptions.
This result illustrates the indeterminate nature of
The preceding example illustrates limited
the tax effect on the break-even lease payment.
possibilities for mutually profitable leasing ar-
The effects of the discount and marginal tax
rangements between agents with different tax
rates are presented graphically in figure 1 for a
rates. However, the above analysis only consid-
four-year lease as discussed above. Break-even
ers the marginal income tax rates. Many
lease payments increase as the discount rate in-
farmers also pay self-employment taxes in ad-
creases for all four marginal tax rates. This
dition to income taxes (VanTassell and Nixon).
result is consistent with the above discussion of
At certain taxable income levels this tax rate is
(11). As the tax rate is increased, the break-
higher than the income tax. If the lessor is not
even lease payment increases for the four-year
subject to self-employment taxes, the lessee
lease. However, this result varies with different
may have a higher tax rate than the lessor, so
lease lengths and size of capital gains from the
that the possibility for leasing may exist. In ad-
asset salvage value.
dition, because capital gains are not subject to
self-employment taxes, the inclusion of self-em-
Price Setting in the Marketplace-The ployment taxes would decrease the break-even
Lessor and the Lessee lease payment derived in equation (7) for the
lessee by changing the numerator of the last
The situations described in table 1 and figure 1
term from G,-TV, to G,-KV,, where K is the
yield insights into the market relationship be- income tax rate, and T is the sum of
marginal
tween the lessee and the lessor. As shown the marginal income tax and self-employment
previously, the lessee and the lessor havetax iden-
rates, which would further increase possi-

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 Ford and Musser Lease-Purchase Decision 283

$10
1=$38,000

$9 ------O ------------------------------------ -.- -

PC

PC $ 8 /---------- - -- ---------- --.------ - - - - - -- - - - - -

$ B
$7 - --- --
$ ~ A 1=$33,000
$6

$5
6% 8% 10% 12% 14% 16% 18% 20%/c
Discount Rate

Tax rates

-- 0% -- 15% -V 28% -- 33% - 15%

Figure 1. Break-even four-year lease payments varying by discount rate, t

purchase price

bilities for leases. Thus, any opportunity for ato $33,000. An agent able to pur-
been changed
profitable leasing arrangement alsochase depends on for $38,000 would be willing to
a tractor
the change in relative tax rates oflease the aagents
tractor for less than point A at an 8%
due to the consideration of self-employment discount rate, while an agent purchasing a trac-
taxes.
tor for $33,000 would be willing to lease out a
A more likely scenario of a mutually tractorprofit-for more than point E. A lease could be
able lease transaction is that the lessee and arranged along line AE that would be profitable
lessor have different discount rates. If the effec-
to both agents. The profit potential of a leasing
tive discount rate of the lessee is 16%, then the arrangement continues to exist in this example,
lessee's new break-even payment would be even with a difference in the discount rates be-
point C in figure 1. The opportunity for greater tween agents of up to approximately 7%. A
profit for the lessor and a reduced lease pay- similar situation exists for the case where
ment for the lessee would lie on line DB. If, economies of scale result in variable input costs
however, the lessor has a higher discount rate paid by the owner of the asset, M,, that are
than the lessee, then no leasing would occur. lower than those available to the lessee.
Finally, the lessor may be in a position to
purchase assets at a lower price than the lessee
through quantity purchases, lowering the break- Capital Rationing
even lease payment of the lessor, and
Previous analysis assumes that the lessee has
increasing the profit potential of the two parties
parameter values determined in the market.
from a lease agreement. A situation with differ-
However, many farmers considering leasing
ent purchase prices is also illustrated in figure 1
may be subject to capital rationing. In the ex-
for a case where only the purchase price has
treme case of limited equity and limited or zero

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 284 May 1994 Amer. J. Agr. Econ.

available credit,tural theeconomics,lease-purchase

particularly when farmers are
of limited relevance. consideringThe farmer
asset replacement during periodsmay of
sufficient capital for L and not fo financial stress in agriculture.
leasing is the onlyThe model also provides a theoretical
alternative and
to acquir
In cases with more capital,
empirical approach convent
for consideration of the ef-
tal rationing analysis ison appropriate.
fects of parameters the possibility of leasing
Musser, and Tew noted
transactions. that
The theoretical analysiscapital
of these
can be a cause of higher
parameters indicates thatvalues of r
many of their effects
which may provide on leasing a market
are complex for
and indeterminate. Like lea
cussed previously. similar analysis of other
While financial decisions in exi
confusion
appropriate investment agriculture (Musser, Tew, analysis
and White), caution un
rationing, Weingartner demonstrat
is necessary in generalizing numerical analysis
correct discountin rate the absence of theoretical support.
results in In this
the
for projects with positive
particular NPVs
application, theoretical just
and empirical
the upper limit analysis on of the
the discountcapital
rate, marginal taxbudge
rate,
could be determined with an iterative method and asset cost effects on the lease-purchase de-
and would be greater than the market rate, byprovided insight into the relationship of
cision
definition. For a given set of investment oppor- the lessee and lessor in the asset-leasing mar-
tunities, the smaller the maximum capital ket. The effect of the discount rate on
budget, the higher the discount rate. break-even lease payments is straightfo
The basic model described in this paper can and will almost always be positive unles
be interpreted to suggest a further potential ad- lessor provides significant maintenance
vantage of leasing under capital rationing in However, the effect of the marginal tax ra
addition to a divergence in r from that of a les- pends on the term of the lease combined
sor. If the lessee acquires an asset through the asset's depreciation structure. The abilit
leasing, more of the limited capital budget (I0- the lessor to purchase the asset at a lowe
L) would be available for other investments. If than the lessee, not surprisingly, provide
these investments would have a negative NPV portant opportunities for leasing. Finally
when the asset was purchased, the relevant firm existence of capital rationing for the less
discount rate would be lower under leasing than creases the possibility of leasing, as com
when purchasing. As previously discussed, the believed.
discount rate in the denominator of (7) applies Lewellen, Long, and McConnell conclude:
to lease payments, and those in the numerator "in an idealized competitive milieu, a reliable
to cash flows from purchase. If r in the denomi- rationale for leasing attractiveness cannot rea-
nator is lower than in the numerator, L* is larger sonably be maintained" (p. 797). However, this
than if both values are the same as in the ab- conclusion concerned large corporations in a
sence of capital rationing. Therefore, capital competitive environment that had similar dis-
rationing increases the possibility of leasing countbyand marginal tax rates and were unable to
both increasing r and L*. This framework there- capture discounts for high-volume asset pur-
fore confirms that capital rationing increases chases. The structure of the agricultural sector
leasing potential. may provide a different context for the lease-
purchase decision. Many small farm businesses
purchase goods and services from relatively
Implications few large corporations that may enjoy volume
The lease-purchase decision concerns the discounts through economies of scale unavail-
able to individual farmers. The tax effect under
method of financing an asset that has been de-
termined to be a desirable investment with certain lease terms and the possibilities of very
different discount rates among lessees and les-
capital budgeting methods. This paper presents
sors in agriculture supports the idea that asset
a simple approach for evaluating the lease-pur-
leasing
chase decision. A break-even lease payment can may be a viable alternative to purchas-
ing assets for many farmers, while also
be calculated using a minimum of information
that can be compared to market offers providing
of leas- profit potential to firms involved in
ing arrangements. The break-even lease leasing assets to farmers.
payment is also calculated with only one equa-
tion, instead of two as in conventional leasing
[Received December 1992;
analysis. These methods have great potential in
extension farm management work in agricul- final revision received October 1993]

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Ford and Musser Lease-Purchase Decision 285

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