Question

Your company needs a new corporate jet for 5 years. You can either buy or lease it. If you lease it, you need to make a lease payment at the beginning of each year. All prices are in $ million.

	A	B
1	Price of jet	16
2	Resale value after 5 years	8
3	Annual lease payment	1.6
4	Number of lease payments	5
5	Interest rate	12%

Part 1

What is the net advantage to leasing, i.e., the incremental NPV of leasing relative to buying (in $ million)?

Answer 1

Buying -

Price of Jet now = CF₀ = -16
Resale Value after 5 years = CF₅ = 8
Interest rate = r = 12% or 0.12
NPV = CF₀ + CF₅/(1+r)⁵ = -16 + 8/1.12⁵ = -11.46

Leasing -

Annual Lease Payment = 1.6
=> CF₁ = CF₂ = CF₃ = CF₄ = CF₅ = -1.6
Interest Rate = r = 12% or 0.12
NPV = CF₁/(1+r) + CF₂/(1+r)² + CF₃/(1+r)³ + CF₄/(1+r)⁴ + CF₅/(1+r)⁵ = -1.6/1.12 - 1.6/1.12² - 1.6/1.12³ - 1.6/1.12⁴ - 1.6/1.12⁵ = -5.77

Since the Present value of investment is lower for Leasing, leasing is a better option

Incremental NPV for leasing = 11.46 - 5.77 = $5.69m