Question

What is meant by the term "net advantage to leasing (NAL)? How are the cash flows structured? What discount rate should be used?

Answer 1

Answer-

1. Meaning of NET ADVANTAGE TO LEASING -

Net advantage to leasing means the total monetary savings that would result from a person or a business choosing to lease an asset, as opposed to purchase it outright.

The benifits of leasing are usually determined by comparing the ner present value of purchasing the asset outright to the net present value of leasing it.

A net present value calculation is a good way to identify the direct cost comparing of leasing and buying. To obtain an accurate net present value calculation, buyers must determine an estimate timeframe for the comparision

2. STRUCTURE OF CASH FLOW IN NAL

a) In case of lease option

Type of cashflow	Inflow or Outflow	Time Period
Lease rentals	Outflow	Over lease period
Tax shield on lease rentals	Inflow	Over lease period
Processing fees net of tax, if any	Outflow	Year Zero

  

b) In case of borrowing

Type of cashflow	Inflow/outflow	Time period
Purchase of asset	Outflow	Year zero
Borrowing	Inflow	year zero
processing fee net of tax	outflow	year zero
Installment & interest payment	outflow	over loan period
Tax shield on interest	Inflow	Over loan period
Tax shield on depreciation	inflow	over loan period
Salvage value net of tax	Inflow	Last year

3. DISCOUNT RATE TO BE USED

a) When asset is completely or substantially financed by debt, use after tax cost of borrowing = Interest (1-tax rate)

b) Use weighted avg. cost of capital if asset is part financed

c) Use same rate of discount for both lease and borrowing option