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Revisiting the standard lease valuation model: new results

Author

Listed:
  • James A. Miles

    (Smeal College of Business)

  • John R. Ezzell

    (Smeal College of Business)

  • Premal P. Vora

    (Penn State Harrisburg)

Abstract

We revisit the standard model for valuing lease contracts to explore the necessary conditions it implies for a lease to have a non-negative net tax advantage. While the literature commonly places an emphasis on the depreciation tax-savings benefits as a primary source of the benefits from leasing, we demonstrate that they can never produce sufficient tax savings to explain why that asset was leased instead of purchased. Instead, it is the interest tax savings related to the debt supported by lease payments that are necessary for the lease to have a net tax advantage, not the transferred depreciation write-offs. Additionally, we demonstrate that asset characteristics and contract provisions also have an effect on the net tax advantage of a lease. Because asset characteristics and contract provisions have implications for the agency effects of leasing, our analysis demonstrates that an interaction exists between the tax and agency effects of leasing. Our paper provides a better understanding of what drives tax-motivated leasing and dispels some myths surrounding it.

Suggested Citation

  • James A. Miles & John R. Ezzell & Premal P. Vora, 2018. "Revisiting the standard lease valuation model: new results," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 42(2), pages 409-420, April.
    • Handle: RePEc:spr:jecfin:v:42:y:2018:i:2:d:10.1007_s12197-017-9407-9
    DOI: 10.1007/s12197-017-9407-9
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    References listed on IDEAS

    as
    1. Myers, Stewart C & Dill, David A & Bautista, Alberto J, 1976. "Valuation of Financial Lease Contracts," Journal of Finance, American Finance Association, vol. 31(3), pages 799-819, June.
    2. Lewis, Craig M. & Schallheim, James S., 1992. "Are Debt and Leases Substitutes?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 27(4), pages 497-511, December.
    3. Smith, Clifford W, Jr & Wakeman, L MacDonald, 1985. "Determinants of Corporate Leasing Policy," Journal of Finance, American Finance Association, vol. 40(3), pages 895-908, July.
    4. Franks, Julian R & Hodges, Stewart D, 1978. "Valuation of Financial Lease Contracts: A Note," Journal of Finance, American Finance Association, vol. 33(2), pages 657-669, May.
    5. Heaton, Hal, 1986. "Corporate Taxation and Leasing," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 21(3), pages 351-359, September.
    6. Miles, James A. & Ezzell, John R., 1980. "The Weighted Average Cost of Capital, Perfect Capital Markets, and Project Life: A Clarification," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 15(3), pages 719-730, September.
    7. Gordon A. Sick, 1990. "Tax-Adjusted Discount Rates," Management Science, INFORMS, vol. 36(12), pages 1432-1450, December.
    8. Lewellen, Wilbur G & Emery, Douglas R, 1981. "On the Matter of Parity among Financial Obligations," Journal of Finance, American Finance Association, vol. 36(1), pages 97-111, March.
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    More about this item

    Keywords

    Leasing; Valuation; Necessary conditions;
    All these keywords.

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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