Academic journal article Financial Management

A Survey of Corporate Leasing Analysis

Academic journal article Financial Management

A Survey of Corporate Leasing Analysis

Article excerpt

Controversies abound in the finance literature concerning the subject of leasing, Of the many issues on this topic that have been debated over the years, the oldest, and perhaps the most controversial and, therefore, most voluminous, one has centered around the lease versus buy/borrow decision involving financial leases. O'Brien and Nunnally's [11] long list of references was perhaps the most complete literature on this issue just a few years ago. But as the debated has gone on (see, for example, Weingartner [17], Cason [7], and Schall [14] in the Summer 1987 Issue of the Financial Management), their list has fallen behind.

A lessee faces many questions in making a lease versus buy/borrow decision. Important questions are: * Is leasing an investment decision or is it a financing

decision? * Given that leasing is a financial decision, which of

the many models for computing the next advantage

to leasing (NAL) is simple yet theoretically sound? * Should a single rate be used to discount all types

of cash flows in the chosen NAL model? What is

(are) the appropriate discount rate(s)? * How is the IRR of leasing computed? Between

NAL and IRR, which one should be preferred? * If leasing is indeed a financial decision, how is lease

versus buy/borrow analysis incorporated in the

capital budgeting decision? More specially,

should a lease analysis be performed even when a

project is rejected at the capital budgeting stage?

O'Brien and Nunnally [11] attempted to find answers to some of the questions posed above. Their survey results indicate that (i) the companies surveyed generally consider leasing as a financing decision, (ii) most of the companies that use the NAL method discount relevant cash flows at the firm's cost of debt, and (iii) an overwhelming number of firms (75%) do not perform lease analysis for a project that has been] rejected at the capital budgeting stage.

The current study is an update and extension of the O'Brien and Nunnally [11] survey and is justified of the several reason. Firs, to ensure a good response rate, O'Brien and Nunnally [11] limited their questionnaire to a few simple questions. Consequently, some important questions (e.g., which NAL model is most preferred by firms or whether the same discount rate is used for all cash flows, or whether firms prefer IRR ro NAL) were excluded. Since a better understanding of the leasing practice warrants that we know answers to the omitted questions as well, a more comprehensive survey is needed. The current survey attempts to fill this void. Second, the findings as reported by O'Brien and Nunnally [11] do not (i) quantify the extent to which the firms treat leasing as a financing decision (as opposed to a capital budgeting decision), (ii) provide the distribution of the firms in terms of leasing methods employed (NAL versus IRR), and (iii) specify whether the firm's favored discount rate was before- or after-tax cost of debt. This survey attempts to clarify these points.

Third, finance textbooks examined be O'Brien and Nunnally [11] in 1982 differed on how leasing analysis should be performed. For example, according to O'Brien and Nunnally [11], some texts were still advocating a capital budgeting approach and some did not show how the NAL analysis could be tied to the capital budgeting decision. A review of five intermediate-level textbooks in 1989, to be discussed in Section I of this paper, however, reveals that these texts are in general agreement on many aspects of the lease analysis, including the two points of disagreement mentioned in the O'Brien and Nunnally [11] article. Consequently, the current survey may shed new light on their findings. Finally, the current survey expands the scope of the O'Brien and Nunnally [11] survey by including questions on the firms' perception of (i) the relationship (substitute versus complementary) between leasing and debt, (ii) the non-tax view of the law changes. …

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