Finance Leasing Manual - FLM6.19

Lessor's timing advantages: effect of tax

Consider another simplified example. Suppose

• a finance lessor's investment in plant today will save him tax of £1,000,000 in a year's time

• the lessor will have to pay tax of £1,200,000 in five years' time on the profit from leasing the kit.

With a 10% interest rate:

• the 'net present value' of the £1,000,000 saved next year is £909,091 (£909,091 invested today @ 10% yields interest of £90,909 in a year's time; so £909,091 invested now + £90,909 interest amounts to £1,000,000 in a year; or working back from the future sum of £1,000,000 ÷ 110/100 = £909,091)

• the 'net present value' of the £1,200,000 is £745,106 (compounding £745,106 at 10% for five years = £1,200,000; or working back from the future sum of £1,200,000: £1.2m ÷ 1.15 ((110/100) x (110/100) x (110/100) x (110/100) x (110/100)) = £745,106).

In short, the 'net present value' (the 'real' value today) of the £1,000,000 saved early on by the finance lessor (£909,091) is greater than the 'net present value' (the 'real' value today) of the £1,200,000 due in five years (£745,106). So the deal looks profitable for the lessor. The opposite is true if you just look at the nominal cash figures.