Implicit Factors in the Evaluation of Lease vs Buy Alternatives: A Reply.

Abstract This article presents response from the author to a criticism of his article "Implicit Factors in the Evaluation of Lease vs. Buy Alternatives," published in the October 1973 issue of the journal "The Accounting Review." The author's article concluded that, if the implicit interest rate in the lease payments equals the rate at which a firm can borrow and if the depreciation pattern under buy coincides with the quasi-depreciation pattern under leasing, a firm would be indifferent between buying and leasing. He also stated that an implicit interest rate in a lease which exceeds the rate at which a firm can borrow and an accelerated depreciation method under the buy alternative which results in a greater tax shield will favor buying over leasing. It was criticized that the conclusions do not hold if the depreciation life for tax purposes exceeds the lease payment period and that leasing may be preferable even though the implicit interest rate in the lease exceeds the borrowing rate. Since the cash flows resulting from the tax shield should be discounted at the cost-of-capital instead of the borrowing rate, it was assumed that the cost-of-capital equals the borrowing rate since a 6% discount rate was used.