In your firm, what benefits does leasing offer, compared to the purchase of an asset? Provide examples.
Chapter 19 Mini Case
Lewis Securities Inc. has decided to acquire a new market data and
quotation system for its Richmond home office. The system receives
current market prices and other information from several online data
services and then either displays the information on a screen or stores it
for later retrieval by the firm’s brokers. The system also permits
customers to call up current quotes on terminals in the lobby.
The equipment costs $1,000,000 and, if it were purchased, Lewis could
obtain a term loan for the full purchase price at a 10% interest rate.
Although the equipment has a 6-year useful life, it is classified as a
special-purpose computer and therefore falls into the MACRS 3-year
class. If the system were purchased, a 4-year maintenance contract
could be obtained at a cost of $20,000 per year, payable at the beginning
of each year. The equipment would be sold after 4 years, and the best
estimate of its residual value is $200,000. However, because real-time
display system technology is changing rapidly, the actual residual value
As an alternative to the borrow-and-buy plan, the equipment
manufacturer informed Lewis that Consolidated Leasing would be
willing to write a 4-year guideline lease on the equipment, including
maintenance, for payments of $260,000 at the beginning of each year.
Lewis’s marginal federal-plus-state tax rate is 40%. You have been
asked to analyze the lease-versus-purchase decision and, in the process,
to answer the following questions:
1. Who are the two parties to a lease transaction?
2. What are the five primary types of leases, and what are their
3. How are leases classified for tax purposes?
4. What effect does leasing have on a firm’s balance sheet?
5. What effect does leasing have on a firm’s capital structure.
1. What is the present value of owning the equipment? (Hint: Set up a time line
that shows the net cash flows over the period to , and then find the PV of these net
cash flows, or the PV cost of owning.)
2. Explain the rationale for the discount rate you used to find the PV.
c. What is Lewis’s present value of leasing the equipment? (Hint: Again,
construct a time line.)
d. What is the net advantage to leasing (NAL)? Does your analysis indicate
that Lewis should buy or lease the equipment? Explain.
e. Now assume that the equipment’s residual value could be as low as $0
or as high as $400,000, but $200,000 is the expected value. Because the
residual value is riskier than the other relevant cash flows, this
differential risk should be incorporated into the analysis. Describe how
this could be accomplished. (No calculations are necessary, but explain
how you would modify the analysis if calculations were required.) What
effect would the residual value’s increased uncertainty have on Lewis’
f. The lessee compares the present value of owning the equipment with
the present value of leasing it. Now put yourself in the lessor’s shoes. In
a few sentences, how should you analyze the decision to write or not to
write the lease?
Purchase answer to see full attachment