Quasi-Debt Analysis of Financial Leases.

Abstract The use of leases is widespread as a means of acquiring assets, and where such leases provide for payment of substantially the entire cost of an asset during the lease term, the lease has properly been viewed as a form of debt financing, not substantially different from a mortgage in its operating effects. While there has been wide acceptance of the concept of leasing as a form of debt financing, a satisfactory technique for evaluating financial leases has proved to be somewhat elusive. The problem lies in the determination of the "cost" of a lease as compared with debt. It is simple enough to compute the Implicit interest included in the lease payments, but this is insufficient since the use of a lease causes changes in the tax cash flow of the firm. In most textbooks, the analysis of financial leases has generally involved calculating the cash flow, after taxes, of the lease and of the alternative loan, and then discounting these cash flows at the cut-off rate or the cost of capital.