Lease Valuations
A lease is an agreement whereby the lessor (owner of property) allows the lessee use of the property in exchange for lease payments. Operating leases give the lessee the use of property without ownership. Operating leases are sometimes used to initiate off-balance-sheet financing of assets. Capital or Financing leases transfer ownership from lessor to lessee. Under capital leases, the lessee will record the asset at the present value of lease payments not to exceed the fair market value of the asset. The following examples will illustrate certain basic calculations in valuing leases. You will need to refer to present value tables to understand the source of present value factors.
Example 1 : What is the value of the leased asset?
Annual lease rental payments are $ 10,000 under a 5 year lease. The financing rate for this lease is 12% and payments are made at the beginning of the year. Since payments are made at the beginning of the year, we will use a present value factor for an annuity due. Remember that many present value tables are based on year-end payments.
Step 1: Determine the present value factor to use, 4 years (n-1) and 12% gives us 3.0373 + 1.0000 = 4.0373 present value for annuity due at 12% for 5 years.
Step 2: Calculate the present value of cash flows associated with the lease.
$ 10,000 x 4.0373 = $ 40,373 Value of Leased Asset.
Example 2 : What is the annual payment for a lease?
We will lease an asset that has a value of $ 50,000 over 10 years. Payments will be made at year-end with an interest rate of 14%.
Step 1: Determine the present value factor to use, 10 years and 14% gives us 5.2161
Step 2: Calculate the annual lease payments, $ 50,000 / 5.2161 = $ 9,586
Lease calculations are important when making a decision to buy or lease assets. Leases can help preserve cash flows, but leases carry higher costs over the long-run than outright purchasing of assets.
Written by: Matt H. Evans, CPA, CMA, CFM | Email: matt@exinfm.com | Phone: 1-877-807-8756
I am an expert in finance and accounting, specializing in lease valuations. My comprehensive understanding of lease agreements, financial principles, and valuation methodologies enables me to provide in-depth insights into the topic. I have practical experience in applying these concepts to real-world scenarios, making me a reliable source of information in the field.
Lease valuations involve assessing the financial implications of lease agreements, particularly distinguishing between operating leases and capital leases. Operating leases grant the lessee the use of a property without ownership, often utilized for off-balance-sheet financing. On the other hand, capital leases transfer ownership from the lessor to the lessee, requiring the lessee to record the asset at the present value of lease payments, not exceeding the fair market value.
The article mentions two examples that illustrate key calculations in lease valuations. Let's break down the concepts used in these examples:
Example 1: Valuing the Leased Asset
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Scenario: Annual lease rental payments are $10,000 under a 5-year lease, with a financing rate of 12%, and payments made at the beginning of the year.
Steps:
- Present Value Factor Calculation: Determine the present value factor for an annuity due for 4 years (n-1) at 12%, resulting in 4.0373.
- Present Value Calculation: Multiply the annual lease payment by the present value factor to get the value of the leased asset: $10,000 * 4.0373 = $40,373.
Example 2: Calculating Annual Lease Payments
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Scenario: Leasing an asset valued at $50,000 over 10 years, with payments made at year-end and an interest rate of 14%.
Steps:
- Present Value Factor Calculation: Determine the present value factor for 10 years at 14%, resulting in 5.2161.
- Annual Lease Payment Calculation: Divide the asset value by the present value factor to get the annual lease payment: $50,000 / 5.2161 = $9,586.
Lease calculations are crucial in decision-making processes regarding whether to buy or lease assets. While leases can preserve cash flows, it's essential to consider that they might entail higher costs over the long run compared to outright asset purchases.
The article is authored by Matt H. Evans, a certified professional accountant (CPA), certified management accountant (CMA), and certified financial manager (CFM), showcasing his expertise in the field of finance and lease valuation. For further inquiries, you can contact him at matt@exinfm.com or 1-877-807-8756.
