NPV for Operating Lease

FinancialAnalystKid

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Joined
Oct 14, 2004
Messages
779
I've really never worked with NPV nor with calculations dealing with an Operating Lease.

So I'm seeking out some advice and help.

Does anyone have something on Excel that might be useful to me?

Much appreciated!
 
Use pv function instead of NPV if you don't want to make a table as npv needs a series of data. In cell h2 the formula should be
=PV(0.1/12,D2,E2)
 
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Hello again Dave,
brettdj said:
Nate, I think we are generally in agreement.... :)

A lease is a financing decision which is separate to the investing decision.
{snip}
Hmmm, okay we agree here... But we're coming to two different conclusions...

A lease is a financing vehicle for making an investment, it could very well be a purchase or an alternative investement, etc...

brettdj said:
When evaluating a contract or lease, the cost of debt is the appropriate discount rate (taking into account risk, termination clauses etc) to determine whether entering into the contract is the correct decision
{snip}

Negative, and here's why: You're still investing in a vehicle for the purpose of generating return on capital (otherwise you wouldn't do it!) and the cfs associated with completing your end of agreement come from equity and debt financing; hence, I would use the WACC, not a debt rate, which, in all liklihood, understates the relevent cost of capital.

Why is the risk of return on capital reduced on a lease from the investors standpoint? The answer: It isn't. Same operational risk as ordinary operational investments which should be reviewed by applying the WACC, yes-no? Yes.

Triple negative re: contractual agreements. M&A often involves contracts (who buys a company without a contract?!), for example, and here again, time to use the WACC. The decision to involve lawyers and execute tort law is likely to have an impact on your cash flows, but not your discount rate. Contracts don't necessarily speak to risk, contractual obligations are not lived up to on a daily basis!

FYI, your link is somewhat dated, pooling of interests died in the U.S. in the 20th century:

http://www.aicpa.org/pubs/jofa/jul1999/financial_accounting.htm

And the commentary on Purchase Accounting is no longer accurate.

I've bought a few companies in my day and I don't fully agree with that [drastically] oversimplified overview... I surely would not use a debt rate! That's just not right at a conceptual level...

In any case, Happy New Year. :)
 
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Hi Nate,

The question was how to calculate the NPV of an operating lease, ie it is a classic financing lease v buy decision - it is not an investment decision.

Happy New Year :)

Cheers

Dave
 
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Hello,
brettdj said:
The question was how to calculate the NPV of an operating lease, ie it is a classic financing lease v buy decision - it is not an investment decision.
Why not? I.e., how are NPVs not related to investing? They're two different ways to invest in and secure an asset, but it's still an investment... :confused:

And the OP really wants a PV calc., not an NPV...
 
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Hi Nate,

NateO said:
Hello,

Why not? I.e., how are NPVs not related to investing? They're two different ways to invest in and secure an asset, but it's still an investment... :confused:

You are mixing the financing decision of whether to enter into an operating lease (cost of debt) with the original underlying investment decision (WACC).

ie

Investment Decision - do I want to invest in building the gold mine? Use WACC

if yes

Financing Decision - do I buy or lease the trucks that will haul the ore? As an operating lease is a substitue for debt then the cost of debt is the appropriate discount rate to determine whether to owner/operate v lease.

I work in business evaluation of the head office of a major company. The three common evaluation mistakes we see are

1) People using WACC to discount leveraged cashflows (evaluation of leveraged cashflows is discouraged but to be done correctly it should discounted at the cost of equity)
2) People using WACC to evaluate leases rather than cost of debt
3) The use of a corporate WACC rate regardless of the specific asset being evaluated

NateO said:
And the OP really wants a PV calc., not an NPV...

Its splitting hairs to say a PV is required rather than NPV as both sum discounted casflows. A PV is simply an annuity version of NPV with regular equivalent payements, ie it is a limited application of NPV. The Excel PV calc will suffice for a lease if the payments meet these criteria but NPV will give the same answer.

Cheers

Dave
 
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FinancialAnalystKid - are you still with us? :)

These links may be of interest

A paper on how to approach valuing operating leases http://www.stern.nyu.edu/~adamodar/pdfiles/papers/oplev.pdf

And from page 41 of http://pages.stern.nyu.edu/~adamodar/pdfiles/Seminars/techval.pdf

"Operating Lease Expenses: Operating or Financing Expenses

Operating Lease Expenses are treated as operating expenses in computing operating income. In reality, operating lease expenses should be treated as financing expenses, with the following adjustments to earnings and capital:

Debt Value of Operating Leases = PV of Operating Lease Expenses at the pretax cost of debt

Adjusted Operating Earnings = Operating Earnings + Pre-tax cost of Debt *PV of Operating Leases."
Cheers

Dave
 
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Sorry for intruding, but for educational purpose, may i know what is a WACC? Is that working cost of capital? what is A?
 
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@ Chitosunday,

No problem, the financial terms quickly get bogged down in acronyms... :)

WACC = Weighted Average Cost of Capital

It is the weighted average of the cost of debt and cost of equity.

WACC = Ke * E/V+Kd*(1-tc)*D/V
where

Ke = cost of equity
Kd = cost of debt
E = market value of equity
D = market value of debt (not balance sheet debt)
V = total market value of compay
tc = compay taxrate

The cost of equity (Ke) is normally calcualted using the Capital Asset Pricing Model (CAPM)

Ke = Rf+B*(Rm-Rf)+e
Rf = risk free rate of return
B = beta of the investment (the sensistivity of the return of an investment to general market movements)
Rm = expected return from the market
e = random error term (expected value of zero)

It looks ugly but a google search of WACC and CAPM should give you good examples

The WACC is used to discount unleveraged cashflows as both debt and equity holders have claims on these cashflows - so there should be no repayment of debt in the cashflows

@Nate,

on rereading your comment about the OP wanting a PV not a NPV I realise that you may just be disagreeing with the wording of "Net" as the cashflows have no sign change. I interpreted your comments as suggesting that the Excel PV function was better suited than the NPV function for this job which is what I was disagreeing with.

Cheers

Dave
 
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