Most elements of the weighted average cost of capital are
easy to compute. Unlike bonds, mortgages and bank loans, the cost of lease
capital is never stated. Leases vary widely in application fees, down payments,
deposits, prepayments and length all of which make it difficult to specify the
cost of lease capital in a consistent manner. Such terms also make it difficult
to compare leasing to other forms of financing. Lessors have a similar problem.
The return on capital invested in lease assets is difficult to calculate. A
lease with a lower monthly payment may provide greater returns than one with
higher payments if terms are properly specified. A problem that both lessees
and lessors have is that the time value of money functions used to compute the
lease cost of capital give rise to non-linear equations. Solution of those
equations is beyond the skill of most finance and accounting practitioners.
This article provides a standardized framework for specifying lease terms and
an algorithm for solving the resulting non-linear equations. This algorithm can
be implemented using common spreadsheet software.
JEL classification numbers: G23, G32, D24
Keywords: Lease, Lease Cost, Lease Terms, Cost of Capital,