In this bonus lesson, I'm going to show you how to calculate the implicit cost of lease financing. Now, calculating this rate requires you to know only a couple of pieces of information. And then solving for this interest rate using this kind of conceptual equation that I've got on the screen in front of you. First of all, you take the value of the asset that you're thinking about acquiring, and you're going to subtract off the the lease payment, the present value of the lease payments and the present value of the end of lease purchase options are guaranteed residual values. And again, those are the present values, you're gonna have to solve for that interest rate that makes this equation equal to zero. The other things you'll have to possibly adjust for is knowing whether the lease payment is made at the beginning of the period or the end of the period.

This will make a difference as well as you need to exclude any other items that may be bundled with the lease itself such as the the major In services that may be being provided by the lessor. Now fortunately, Excel has a function that can do this calculation for us. The rate function calculates the implicit rate of a lease, given the number of payments, the payment amount per period, the present value of the asset, you think you're acquiring the future value if it has a value at the end, and optionally, this the switch that allows you to determine whether it's a beginning or end up period payment that you're making. Now, the result in interest rate is the rate per period. So if you're doing monthly payments, under your lease, the implicit rate is an effective monthly rate. And so to annualize this rate, you can simply multiply it by 12.

If you set the type to a one in this formula, Excel is going to assume that the payments occur at the beginning of the period. And if you set that type, switch to zero and or emit the argument then Excel is good. Assume that the payments are occurring at the end of each of the lease periods. So let's see how you do using this example. What I want you to do is to open up a spreadsheet, read these case facts and answer the three questions at the bottom of this screen. So pause the video now and do not continue until you're done.

Are you pausing? Here's the solution. So once again, ABC should use the bank financing to purchase the equipment. As the 9% interest rate on the equipment loan is less than the 14.3 implicit lease rate. You can pause the video again to review your calculations. I've used both the rate function as well as done the longhand form to kind of prove it to you at the bottom of the screen.

Now as for the answer to question three, ABC also needs to consider some of the following which may favor one approach over the other the tax implication Certain equipment may be depreciated for tax purposes more quickly than the lease payments, giving the company an additional tax advantage, maintenance and warranty costs, it may be beneficial to lease equipment when maintenance is included or there's a concern about the amount of maintenance or whether even ABC has the expertise to maintain the equipment themselves. obsolescence might be another factor. If the company is concerned about the equipment becoming out of date, then perhaps a shorter time horizon, using a lease might be a better idea than buying the equipment, which may be obsolete before it's gone through its useful life. And then finally, the financing implications. And so the different terms may also be important, you may be able to negotiate a longer financing term which gives you more clarity and certainty of the amount of amount of payments versus say, a shorter term that may be offered by the bank and it cheaper interest rate, but leaves you with that refinancing risk at the end of the loan.

So that's all for this bonus lesson and I hope that helps you the next time you're confronted with a lease versus buy decision