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Issues in Lease Evaluation

How should a lease be evaluated? Vikalpa published an article on “Myths and Realities about Leasing” (October- December 1986) in which I M Pandey introduced two methods of evaluation, the Equivalent Loan Method and the Net Advantage of Leasing Method. Pandey considered the impact ofa lease as functionally equivalent to that of debt. He used the borrowing rate to discount lease rentals and tax shields in both methods. In the April-June 1987 issue, Vikalpa carried an article by V Raghunathan entitled “Better Evaluation of a Lease.” Raghunathan critiqued Pandey's approach. He proposed a method involving a comparison between purchasing an asset and leasing it, treating each as an investment decision. He used the weighted average cost of capital for discounting cashflows. In this Notes and Comments feature, the authors discuss the conceptual issues underlying these methods of evaluating a lease.