This document provides an overview of evaluating a lease from the lessor's viewpoint. It discusses calculating the net present value (NPV) of a lease by determining the present value of cash inflows such as lease rentals and the residual value, and cash outflows like depreciation and taxes. An example is provided to illustrate calculating the NPV of a 5-year lease with given parameters like acquisition cost, lease rentals, tax rate, salvage value, etc. The NPV is negative, suggesting it is not financially profitable for the lessor to accept the lease. The document also shows how to calculate the break-even lease rental that would result in an NPV of zero.

1. LEASE EVALUATION
LESSOR’S VIEWPOINT
Prepared by-
LALIT VERMA
15-MBAK-99
ALIGARH MUSLIM UNIVERSITY

2. LESSOR’S VIEWPOINT
 Aims to ascertain whether to accept a lease proposal or to choose from alternative
proposal
Outflow-
 out flow in terms of initial investment/acquisition cost of the assets
 Income tax on lease payment
 Sales tax on lease transaction
 Lease administration expenses such as rental collection charges, direct cost and so on.
Inflow-
 Lease rental
 Tax shield on depreciation
 Residual value
 Security deposit

3. calculation required in lease evaluation
1. Schedule for determination of NPV of cash flows
2. Depreciation calculation with written down value of equipment for each year
3. Short-term capital loss/gain calculation
4. Tax saving on short-term loss
5. PVIF & PVIFA also required

4. Question
We can understand with the help of example-:
Q- Machinery cost- Rs 15,00,000
expected useful life 5 years
tax rate – 35%
lease rental – Rs 4,50,000
lease rent are paid at the end of each year
depreciation rate – 25% by written down value method
cost of capital- 14%
Salvage value after five year- Rs 1,00,000

5. Depreciation calculation
year Written down
value
Depreciation
1 15,00,000 3,75,000
2 11,25,000 2,81,250
3 8,43,750 2,10,937.5
4 6,32,812.5 1,58,203.1
5 474,609.4 1,18,652.35
6 3,55,957.05

6. Determination of NPV of cash flows
1 year 2 year 3 year 4 year 5 year
Lease rent 4,50,000 4,50,000 4,50,000 4,50,000 4,50,000
Less-
depreciation
3,75,000 2,81,250 2,10,937 1,58,203 1,18,652
Earning before
taxes
75,000 1,68,750 2,93,063 291,797 3,31,348
Less- taxes
35%
26,250 59,062 83,672 1,02,129 1,15,972
EAT 48,750 1,09,688 1,55,391 189,688 2,15,376
Earning after tax
but before dep.
4,23,750 3,90,938 3,66,328 3,47,871 3,34,028
PVIF at 14% 0.877 0.769 0.675 0.592 0.519
Present value 3,71,629 3,00,631 2,47,271 2,05,940 1,73,361
Total PV of five years = 12,98,832

7. Total PV present value of five years- 12,98,832
add- PV of salvage value of machine 51,900
(1,00,000 × 0.519)
add- PV of tax saving on short term capital loss 46,495
(89,585 × 0.519)
---------------
Gross PV 13,97,277
less- cost of machine ( 15,00,000)
------------------
NPV ( 1,02,733)
Suggestion – It is not financial profitable to let out machine on lease by the leasing
company, as NPV is negative.

8. Calculation of short-term capital loss-:
Written down value at the end of fifth year - 3,55,957.05
less- salvage value at the end of fifth year- 1,00,000
------------------
short term capital loss 2,55,957.05
Tax saving on short-term capital loss-:
Short term capital loss × tax rate applicable
= 2,55,957.05 × 35%
= 89,584. 95

9. Format
Lease rent -----
Less- depreciation -----
--------------
Earning before taxes ------
less- taxes ------
-------------
Earning after taxes --------
Earning after taxes but before ---------
Deprecation
( lease rent –tax)
multiple - PVIF factor ---------
Present value ---------
Now we will add present values of all years = ----------

10. Format
Total PV present value of several years- -------
add- PV of salvage value of machine ------
add- PV of tax saving on short term capital loss -------
if any
---------------
Gross PV --------
less- cost of machine -------
------------------
NPV -------
Decision will be based on NPV

11. How to calculate break even rental

12. Steprequired in calculating break even lease rental
1- Calculation of depreciation
2- Schedule of tax benefit on depreciation
3-Present value of tax benefit on depreciation
4- Schedule for short term capital loss/gain
5- Tax saving on short term capital loss
6- PV of tax benefit on capital loss
7- PV of salvage value
8-Final schedule for break even lease rental

13. We can understand with the help of example
Q- Machinery cost- Rs 15,00,000
expected useful life 5 years
tax rate – 35%
lease rent are paid at the end of each year
depreciation rate – 25% by written down value method
cost of capital- 14%
Salvage value after five year- Rs 1,00,000
Calculate break even lease rental

14. Solution-:
1- Calculation of depreciation-:
year Written down value depreciation
1 15,00,000 3,75,000
2 11,25,000 2,81,250
3 8,43,750 2,10,937.5
4 6,32,812.5 1,58,203.1
5 4,74,609.4 1,18,652.35
6 3,55,957.05

15. 2- Schedule of tax benefit on depreciation-
year Depreciation Tax @ 35%
1 3,75,000 1,31,250
2 2,81,250 98,437.50
3 2,10,937.50 73,828.125
4 1,58,203.10 55,371.085
5 1,18,652.35 41,528.3225

16. 3-Present value of tax benefit on depreciation
year Tax on dep. PVIF PRESENT VALUE
1 1,31,250 0.877 1,15,106.25
2 98,437.5 0.769 75,698.4375
3 73,828.125 0.675 49,833.9843
4 55,371.085 0.592 32,779.6823
5 41,528.3225 0.519 21,553.1993
Total
294971.5534

17. 4- Schedule for short term capital loss/gain
Written down value at the end of fifth year - 3,55,957.05
less- salvage value at the end of fifth year- 1,00,000
------------------
short term capital loss 2,55,957.05
5- Tax saving on short term capital loss
Short term capital loss × tax rate applicable
= 2,55,957.05 × 35%
= 89,584. 9675
6- PV of tax benefit on capital loss
= 89,584.9675 × 0.519
= 46494.59

18. 7- PV of salvage value-
= 1,00,000 × 0.519
= 51,900
Final schedule for breakevenlease rental
cost of machine 15,00,000
Less- PV of tax benefits on depreciation (2,94,972)
Less- PV of tax benefit on capital loss (46,494.59)
Less- PV salvage value (51,900)
Total break even lease rental 11,06,633.41

19. Total break even lease rental 11,06,633.41
now we will divide total break even lease rental with PVIFA @ (14%, 5 years)
= 11,06,633.41 ÷ 3.433
= 3,22,351.706
break even lease rental - = 3,22,351.706 ÷ (1-0.35)
= 4,95,925.70 answer
or
= 4,95,926