5. The lessor's lease evaluation

There are two parties in any lease contractthe lessee and the lessor. To a lessor, a lease analysis involves a capital budgeting analysis of the property or equipment to be leased. The lessors decision is either to purchase and lease-out the asset, or not make the investment at all.

Like any capital budgeting decision, the lessor needs to evaluate the rate of return expected to be earned from making the lease. Further, since the cost and other terms of leases involving high-cost items are negotiated, this rate of return information is also important information for a prospective lessee.

From the following statements, identify the steps involved in lease analysis from a lessors perspective. Check all that apply.

Determine the lease payments minus income taxes and any maintenance expenses that the lessor must incur as per the lease agreement.

Determine the invoice price of the leased equipment minus any lease payments made in advance.

Check and ensure that the NPV of the lease remains negative.

Determine the periodic cash outflow that the lessor owes to the lessee.

Pele Corp. is a professional leasing company. The leasing manager has to evaluate some lease agreements under the following conditions:

	The companys marginal federal-plus-state income tax rate is 30%.
	The company has alternative investment options of similar risk that yield 5.50%.

Assuming all other factors and values are constant among these leases, from the lessors perspective, which of the following is the best lease?

A lease that has an NPV of $81,000.

A lease that has an IRR of 4.65%.

A lease that has an MIRR of 3.05%.

A lease that generates an after-tax rate of return of 3.35%.

You probably noticed that lease analysis seems a bit like capital budgeting analysis, because the cash flows are estimated over the life of the project or lease. The present value of the cash flows dictates the managers decision. Are cash flows that are estimated in lease analysis more or less risky than capital budgeting cash flows?

More risky

Less risky