Question

Please comment on the following remark:

(a) ‘Leasing is a zero sum game between the lessee and lessor.’

(b) Briefly discuss the reasons for firms to lease even if NALs are negative.

Answer 1

Answer(a):

Leasing refers to a contractual arrangement wherein the Lessee obtains the right to use an asset for a period of time under an obligation to pay regular rental payments to the Lessor who is the legal owner of the asset.

The rental payments are calculated considering the value of the leased asset and the required rate of return, such that the present value of all the future rental payment is equal to the value of the leased asset.

Zero Sum Game refers to an economic theory wherein in a given situation the total gain made by one party is exactly equals the loss made by the other party. In simple terms, if the loss made by one party is subtracted from the profit made by the other party then the answer should be zero.

Under leasing, the Lessee makes fixed periodic payments to the lessor which involves an element of interest at the required rate of return of the lessor. This interest amount is the loss suffered by the lessee and the profit made by the lessor.

For example, if Mr A takes on 2-year lease an asset costing Rs. 20,000 from Mr B for which the fixed annual instalments are at 10%.

Fixed Monthly Instalment	Interest Amount	Principle Amount	Profit by Lessor (Mr B)/Loss by Lessee (Mr A)
11,523	2,000	9,523	2,000
11,523	1,047	10,475	1,047

So it is clear from the above example that the total profit made by Mr B is equal to the loss made by Mr A in terms of Interest payments. Hence Leasing is a Zero Sum Game between Lessee and Lessor.

Answer (b):

Despite Net Advantage to Leasing (NAL) is negative firm may lease an asset due to the following reasons:

1. Buying an asset involves a huge initial cash outflow whereas in leasing firm will have to pay a minimal advance payment and periodic rental payments which can then also be paid out of the cash flow generated by the asset.
2. A firm can quickly acquire an asset through leasing and put it into the required use hence preventing delay in any other projects dependent on the asset.
3. Since leasing helps in conserving the capital, the amount can be utilised in other projects/assets having a better return on investment.
4. Leasing can help a firm to avoid technological obsolescence i.e. leasing an asset which may get obsolete in a few years which can be replaced by leasing the newer version in the future which may not be possible if the firm decides to buy instead of leasing.