The formulas
- After-tax rate = borrowing rate x (1 - tax rate)
- Buy = price - PV(straight-line depreciation x tax rate) - PV(salvage x (1 - tax rate))
- Lease = PV of lease payment x (1 - tax rate), annuity due
- Net advantage to leasing = buy - lease
How it works
A lease is a substitute for borrowing to buy, so both options are discounted at the after-tax cost of debt. Buying costs the price today, less the tax saved by depreciation each year and the after-tax salvage at the end. Leasing costs the after-tax payments, made at the start of each year.
This model depreciates the asset straight-line to zero over the term and taxes the whole salvage as gain. Bonus depreciation, Section 179 or MACRS front-load the tax shield and make buying cheaper than shown here. Maintenance, insurance and end-of-lease charges that differ between the options belong in the payment or price.
Illustrative figures only. Check the result against your firm's methodology before relying on it.
Common questions
Why the after-tax borrowing rate?
Lease payments are as certain as debt service. Discounting at the debt rate compares like with like.
Does ASC 842 change the answer?
No. Lease accounting moves the lease onto the balance sheet but does not change cash flows or tax.
What if I would pay cash rather than borrow?
Use the same rate. Cash used to buy has the opportunity cost of debt you could have repaid or avoided.
Formulas on this page are the standard definitions.
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