CHAPTER 27
THE DECISION TO LEASE OR BUY AT
WARF COMPUTERS
1. The decision to buy or lease is made by looking at the incremental cash flows. The incremental cash
Aftertax salvage value = $780,000 – $780,000(.35)
This is an opportunity cost to Warf Computers since if the company leases the equipment it will not
be able to sell the equipment in four years. The lease payments are due at the beginning of each year,
so the incremental cash flows are:
Year 0 Year 1 Year 2 Year 3 Year 4
Saved purchase $6,100,000
Lost salvage value –$507,000
The aftertax cost of debt is:
And the NAL of the lease is:
The company should lease the equipment.
2. The book value of the equipment in year 2 will be:
So, the aftertax salvage value in Year 2 will be:
So, the NAL of the lease under the new terms would be:
Year 0 Year 1 Year 2
Saved purchase $6,100,000
Lost salvage value –$2,554,397
So, the NAL of the lease under these terms is:
This is less than 90 percent of the price of the equipment. As long as the lease contract does transfer
ownership to the lessee at the end of the contact, or allow for a purchase at a bargain price, the FAS
3. a. The inclusion of a right to purchase the equipment will have no effect on the value of the lease.
b. The right to purchase the equipment at a fixed price will increase the value of the lease. If the
company can purchase the equipment at the end of the lease at below market value, it will save
c. The right to purchase the equipment at a bargain price is also a real option for the lessee, and
4. The cancellation option is also a real option. The cancellation option is a put option on the