1 The Issue

　　A company may acquire an asset through:

　　a straight purchase (i.e. borrowing to buy); or

　　a lease.

　　There are two main types of leases:

　　1. Operating lease: the asset is rented for a relatively short part of its useful economic life.

　　2. Finance lease (also called "capital lease"): the asset is leased for most of its life.

　　Although the distinction between operating and finance lease is currently important in financial reporting, it is not so relevant in financial management.

　　The important issue for financial management is the cash flows created by a lease, as compared to a straight purchase of the asset.

　　2 Decision-Making

　　2.1 Investment Decision

　　Discount the cash flows from using the asset (sales, materials, labour, overheads, tax on net cash flows, etc) at the firm's weighted average cost of capital (WACC).

　　2.2 Financing Decision

　　Discount the cash flows specific to each financing option at the after-tax cost of debt.

　　The preferred financing option is that with the lowest NPV of cost.

　　The relevant cash flows to consider include:

　　Buy asset

　　Purchase cost

　　Tax saving on WDAs

　　Scrap proceeds

　　Lease asset (operating or finance lease)

　　Lease payments

　　Tax saving on lease payments

　　2.3 Decision Criterion

　　3 Evaluation Using Pre-tax Cost of Debt

　　If a firm is not in a tax-paying position, there are implications for a lease-versus-buy decision process:

　　No tax savings would be available from capital allowances if the asset was bought.

　　No tax savings would be available on lease payments (either under an operating or finance lease).

　　There would be no tax shield on debt (i.e. interest expense on borrowings would not lead to tax savings).

　　The last point means that the discount rate to use to evaluate the financing options should be the pre-tax cost of debt (i.e. the gross interest rate quoted on a bank loan, or gross redemption yield if borrowing would be in the form of bonds).

　　Situations where a firm is not in a tax-paying position include:

　　losses in current year;

　　losses are brought forward from prior years;

　　incorporation in a tax-free special economic zone;

　　tax holidays granted by the host government; and/or

　　tax-exempt charitable status.