Guidance on the meaning of net present value is at
BLM11210.
Assume market interest rates are 10% a year payable annually
in arrear. This means a sum of £1000 today will be worth
£1100 in a year's time. So, ignoring questions of credit risk
and profit margin etc, you should be able to sell your entitlement
to a sum of £1100 in a year's time for £1000 today. Put
another way, the 'present value' of that future entitlement to
£1100 is £1000. Similarly, the present value of an
entitlement to £1210 in two years is also £1000 (because
£1000 compounded at 10% is £1210).
The intervals at which compounding of interest occurs can
have a significant effect. Interest at 10% calculated at monthly
rests is worth more than interest at 10% calculated at annual
rests. Interest is earned on interest earlier in the monthly case.
These simple examples of the 'time-value-of-money' illustrate
the principles which lie at the heart of leasing calculations. The
lessor's upfront tax losses save tax (or generate repayments) in
the early part of the lease. In due course the lessor will have to
pay tax on their profit. The tax on later rentals receivable should
be more than the tax saved upfront (because earnings exceed
expenses overall). But the upfront tax saved can be worth more
(have a greater present value) than the larger amount of tax the
lessor eventually has to pay on the profits in the future.
