Finance Leasing Manual - FLM6.22

Lessor's timing advantages: finance lessor's approach

In practice sophisticated finance lessees may well use a 'net present value' analysis, see FLM6.19. But finance lessors generally approach the analysis from another direction. Generally, lessors will want to make a specified margin on their funds. For example, a lessor may decide that it wants to make an interest turn of 2% on the capital invested in its finance leases. So it feeds 2% into the computer program, together with other knowns - the cost of the kit (the 'loan'), the cost of money, its likely expenses, the tax rates, the capital allowances rates, the rental payment dates etc - and out comes the rentals the lessor needs to charge to make a 2% turn. Although the starting point is different, the maths in the program rely on the time-value-of-money concepts previously outlined.

No doubt in the real world lessors will depart from their theoretical target return. They may charge more if the risk of default is greater or if the market will bear it. They may charge less if competition is fierce and they are trying to gain market share. Small ticket lessees are generally charged more than big ticket lessees. Computers obviously take a lot of the grind out of finding at what level the lessor can afford to pitch the rental (or the price paid in a sale and-leaseback deal) and still make a profit.

Lessors can also get quick answers for any kind of scenario that suits the lessee. For example, often lessees want to match the profits from a new asset with the rental payments. So they want low or nil rentals when a major asset is being built (possibly over several years) and while production builds up. As the lessee's profits begin to increase as the asset comes on stream the lessee can increasingly afford larger rentals. So they want a rental profile that rises over time (a 'stepped' rental profile).