The following tables demonstrate how you can use a cash flow analysis to assist you with a lease-or-buy

decision. In
this case, if cost were the sole criterion for the decision, we would be inclined to purchase the asset because in
current dollars, the cost of purchasing is $32,204, while the cost of leasing is $34,838. Even if cost isn't your sole
criterion, a cash flow analysis is useful because it can show you how much you're paying for non-cost factors that
may dictate your decision to lease.
Cash flow analysis of purchase. This analysis assumes the financed purchase of a $50,000 piece of equipment for
25 percent down, interest at 10 percent, and four annual payments of $11,830 (all payments are made on the first day
of the year).
Interest is deemed to accrue on the outstanding balance of the loan at the end of each year and is computed as
follows (the last column shows the portion of each annual payment that goes to principal and that reduces the
outstanding loan):

Year End
1
2
3
4

Outstanding
Loan
37500
29420
20532
10755

Interest

Principal

3570
2942
2053
1075

8080
8888
9777
10755

Depreciation is computed on the basis of the 200 percent declining balance method.

A
Year

B
Cash
paymen
t

C
Prior
years
interest

1
2
3
4
5
6
7
8
9
Net
cash
flow

12500
11830
11830
11830
11830

0
0
3750
2942
2053
1075

D
Prior
Years
Depreciati
on
0
10000
16000
9600
5760
5760
2880

2500

E
Tax
savings
[40%+
(c+d)]
0
4000
7900
5017
3125
2734
1152

F
Net
cash
flow (BE)
12500
7830
3930
6813
8705
2734
1152

G
Discoun
t factor
6% cost
of cap.
1.000
.9434
.8900
.8396
.7921
.7473
.7050

h
Present
Value
(F*G)

1000

1500

.6274

941
32204

12500
7387
3498
5720
6895
2043
812

Cash flow analysis of leasing:

This analysis assumes that equipment costing $50,000 will be leased for eight
years for an annual rent of $8,500, with the first payment being due on delivery and
the following payments being due on the first day of each subsequent year. The
business is assumed to have a combined federal and state income tax rate of 40

percent (tax benefits are computed as of the first day of year following the year for
which the rental deduction was claimed) and a 6 percent cost of capital.
A
Year

Lease
Payment

Prior Year's
Tax Savings
[40% x B]

Net Cash Flow

[B - C]

1
2
3
4
5
6
7
8
9
Net Cash
Flow

8,500
8,500
8,500
8,500
8,500
8,500
8,500
8,500

3,400
3,400
3,400
3,400
3,400
3,400
3,400
3,400

8,500
5,100
5,100
5,100
5,100
5,100
5,100
5,100
3400

F
Discount
Factor (6%
Cost of
Capital)

1.000
.9434
.8900
.8396
.7921
.7473
.7050
.6651
.6274

On the basis of cash flow we can say that buy back option is better.

Present Value
[D x E]

8500
4811
4539
4282
4040
3811
3596
3392
2133
34838