Abstract The article presents the effect of implicit interest rates and the depreciation method used in evaluating lease versus buy decisions. Defining and measuring the cost of capital for use in the investment decision are regarded as separate problems. It is assumed to be given and does not enter the analysis. A basic assumption of this paper is that the lease is a financial lease and, therefore, is similar to long-term debt from an analysis standpoint. If the firm leases, the periodic lease payments are tax deductible, whereas if the firm buys, the acquisition cost is tax deductible through time in the form of depreciation. The approach presented in this paper highlights two factors that must be considered in every lease vs. buy decision. One is the implicit interest rate in the lease payments as compared to the firm's borrowing rate. If the implicit interest rate in the lease exceeds the rate at which the firm could borrow, borrowing and buying would be preferred. The second factor is the tax shield effects of the non-interest deduction in the lease payments as compared to permissible depreciation patterns under buying.
Lanny G. Chasteen (Mon,) studied this question.