LEASE VS.

BUY Car
Inputs
Discount Rate 8.0%

Lease 0 1 2 3
Lease Payment $4,100 $4,100 $4,100 $4,100
Present Value of Each Cash Flow $4,100 $3,796 $3,515 $3,255
Present Value of Lease Cost $14,666

Buy 0 1 2 3 4
Purchase Price and Residual Value $32,000 ($21,000)
Present Value of Each Cash Flow $32,000 $0 $0 $0 ($15,436)
Present Value of Buy Cost $16,564
LEASE VS. BUY Corporate
Inputs
Machine lease payment $5,400
Loan rate 6%
Number of loan payments 5
Corporate tax rate 40%
After tax loan rate 3.6%

Lease 0 1 2 3 4 5 6
After-Tax Lease Payment $3,240 $3,240 $3,240 $3,240 $3,240
Residual Purchase Cost $12,600
After-Tax Cash Flows $3,240 $3,240 $3,240 $3,240 $15,840
Present Value of Each Cash Flow $3,240 $3,127 $3,019 $2,914 $13,750
Present Value of Lease Cost $26,050

Buy 0 1 2 3 4 5 6
1. You are trying to decide whether to lease a car for four years or buy a new car now and sell it four years later.
The annual lease payment would be $7,300 with payments made at the beginning of each year. The new car
price is $49,000 now. Four years later, it will be worth $33,000. The appropriate discount rate for this project is
6.9%. Should you lease or buy?

Inputs
Discount Rate 6.9%

Lease 0 1 2 3
Lease Payment $7,300 $4,100 $4,100 $4,100
Present Value of Each Cash Flow $7,300 $6,829 $6,388 $5,976
Present Value of Lease Cost $26,493

Buy 0 1 2 3 4
Purchase Price and Residual Value $49,000 ($33,000)
Present Value of Each Cash Flow $49,000 $0 $0 $0 ($25,270)
Present Value of Buy Cost $23,730
 2. A corporation is trying to decide whether to lease a machine for five years and pay the residual purchase
cost to buy the machine in the last year of the lease or buy the machine now. The annual lease payment would
be $9,000 with payments made at the beginning of each year. The residual purchase cost would be $25,200 to
be paid at the beginning of the fifth year. The lease payments are standard business expenses that reduce the
corporation’s tax liability accordingly. $89,300 can be borrowed from the bank to buy the machine now. Annual
loan payments would be made for 5 years at a 6% interest rate. The machine can be fully depreciated in a
straight line manner over 5 years. Both the loan interest payment and the depreciation provide tax shields
against a corporate tax rate of 40%. The appropriate discount rate for both alternatives is the after-tax cost of
debt, where the corporation’s cost of debt is assumed to be the same as the loan rate. Should the corporation
lease or buy?

Inputs
Machine lease payment $9,000
Loan rate 6%
Number of loan payments 5
Corporate tax rate 40%
After tax loan rate 3.6%

Lease 0 1 2 3 4 5 6
After-Tax Lease Payment $5,400 $5,400 $5,400 $5,400 $5,400
Residual Purchase Cost $25,200
After-Tax Cash Flows $5,400 $5,400 $5,400 $5,400 $30,600
Present Value of Each Cash Flow $5,400 $5,212 $5,031 $4,856 $26,563
Present Value of Lease Cost $47,063

Buy 0 1 2 3 4 5 6