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Break even lease

Shobhit Jain (CA) (4896 Points)

16 March 2018

Break even lease

Lessee Perspective
Calculation of NPV (L) / NAL:
Cost of Asset
Less: PV of Lease rentals (LR)
Add: PV of tax shield on LR
Less: PV of debt tax shield
Less: PV of interest tax shield on displaced debt
Less: PV of salvage value

Lessor perspective

Cost of Machine

Less: - PV of Salvage Value

Less: PV of Tax benefit on Depreciation

Less: PV of Tax Saving on STCL

Please someone explain logic behind these formulas.

What to add and why?

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Nivedita Singh (228 Points)
Replied 23 March 2018

Lessee perspective:
1) add opportunity gain
2) less direct cash outflow of lease rent
3) tax shield on lease rent as lease rent is allowable expenditure under tax laws. so tax is saved.
4) less tax shield on depreciation lost. this is opportunity cost of not taking loan and owning the asset.
5) less tax shield on interest of debt is opportunity cost of not choosing loan option.
6) less salvage value. again this is opportunity cost of not owning the asset.
Thus if NPV is positive lease option is chosen.

Lessor's perspective:
these figures are in terms of cost i.e. outflow is positive and inflows are negative
1) cost of machine is direct outflow on puchase
2)less salvage value is direct inflow of last year
3) less tax shield on depreciation is direct tax savings
4)add/less tax on STCG/STCL on salvage transaction, as the case may be.
the remaining figure is the minimum lease rental required for break even.

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