It’s the Lease We Can Do
In our Tasha example, a lease payment of $2,500 makes the lease unattractive to Tasha, and a lease payment of $2,000 makes the lease very attractive. What payment would leave Tasha indifferent between leasing and not leasing? Tasha will be indifferent when the NPV from leasing is zero. For this to happen, the present value of the cash flows from leasing instead of buying will have to be $10,000. From our previous efforts, we know that the lease payment must be somewhere between $2,500 and $2,000. To find the exact payment, we note that there are five payments and the relevant rate is 5 percent per year, so the cash flow from leasing instead of borrowing must be $2,309.75 per year.
Now that we have the cash flow from leasing instead of borrowing, we have to work backwards to find the lease payment that produces this cash flow. Suppose we let LP stand for the lease payment. Referring back to Table 26.2, we see that we must have that LP ×(1 .34) $680 =$2,309.75. With a little algebra, we see that the zero NPV lease payment is $2,469.32.
CONCEPT QUESTIONS
a Why do we say that leasing is a zero sum game?
b What paradox does the previous question create?