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Working Capital Financing^377

340,000 at t = 0 from the first lease payment, another Rs 340,000 at t ñ1 for the second
payment, and so on. The rate of return for the lessor is that discount rate which equates
the sum of the present values of lease payments with Rs 1.68 crore. Or

Rs 1,680,000s = E^5 t=0 Rs 340,000 (1+r) ñt = Rs 340,000 (E^5 t=0 (1+r)-t

= Rs 340,000^ (1+ E^5 t=1 (1+r)-t (3)

= Rs 340,000 (1 + IFA5/r)

Equation 3 can be restated in terms of the annuity factor IFA as

IFA5/r = (Rs 1,680,000/Rs 340,000 ñ 1 =3.941 18 (4)

From Appendix B IFA (5 year/8 per cent) IS 3.99271 and IFA (5year/9 per cent) is
3.88965. By interpolation r is found to be 8.5 per cent. A way of identifying the leasing
cost is to consider this 8.5 per cent return to the lessor as the 4 lesseeís cost of leasing.

It should be recognised that in calculating the cost of leasing this way, we are ignoring
tax effects and consequently depreciation as a tax shield. This method, however, does
provide us with a reasonable perspective on leasing cost.

Equation 4 can be generalised to estimate the lessorís rate of return on any lease. If it
is assumed that the first lease payment is made at the time the equipment is installed,
then

IFAnñ1/r = C/L ñ1 (5)

Where

n = length of lease

C = cost of equipment

L = annual lease payment

r = lessorís rate of return on the lease

The annuity factor can be used in conjunction with Appendix B to solve for r as shown
in the example given previously.

One interesting factor to note is that the gross lease capitalised value does not necessarily
have to equal the cost of the equipment being leased. The answer lies in the fact that
the lessorsí rate of return is generally different from the lesseeís lease capitalisation
rate.

Advantages and Disadvantages of Leasing

Leasing equipment possesses a variety of advantages and disadvantages for the lessee.