What Is Net Advantage to Leasing (NAL)?
Net leasing advantage (NAL) refers to the total monetary savings which a person or business might incur if they decide to lease an asset rather than purchase it outright. If an NAL calculation represents a positive value, it is an indication that leasing is a better alternative to buying.
The benefits of leasing are generally calculated by comparing the net present value of the purchase of the asset to the net present value of leasing the same asset. The cost analysis of friction can also be used to calculate direct as well as indirect costs.
How It Works?
NAL is an option that both individuals and companies can use to calculate the difference in the cost of purchasing versus leasing. Users will typically opt for leasing over purchases as a result of lower monthly expenses, cost savings, and other added benefits. Leasing versus buying has a variety of direct and indirect costs that can be measured by calculating their net present value and employing friction cost analysis.
For example, imagine a business owner needs to add a delivery vehicle to their operations. They can either purchase the vehicle for $100,000 or lease it for $24,000 a year. The choice is conflicting given the owner can access unique advantages with either option.
If the owner buys the vehicle outright, they can record a depreciation expense each year, but they can’t do so if they lease it. This means, they’ll lose out on the benefit of lower taxable net income. Then again, they’ll also be responsible for maintenance and repairs after buying it. If they lease it, they might not need to bear these charges.
Two Ways To Look At NAL
Net advantage to leasing is basically determined in two different ways. Here is a brief explanation.
Understanding NAL Through Net Present Value
Net present value is among the best ways of calculating the direct cost when determining whether to buy or lease a vehicle. To get an exact calculation of the net present value, the buyers need to determine the assessed timeframe for evaluation. The timeframe is based on the lifecycle of the vehicle and is inclusive of the salvage value.
As per the ownership outlook, the considerations would basically focus on the auto loan payments and the rate of interest anticipated. Through the net present value calculation, the buyer will receive the net present value of the asset compared to the annual average cost.
Understanding NAL Through Friction Cost Analysis
Friction cost analysis involves aggregating all of the direct costs and indirect costs when making the NAL calculation. Friction cost analysis is obtained from the calculation of basic net present value. In this process, prospective car buyers or lessees are permitted to make adjustments to the values based on the measures of the assigned indirect costs. This includes calculating the advantage of returning a car after leasing against the holding cost of the car for its complete lifecycle.
A good example of this in practice involves investing. Consider an investment in an index fund that tracks the S&P 500. The index fund return which tracks the actual index is generally lower than the S&P 500 returns due to the expenses, fees, and other related costs associated with fund management. If the friction cost is high, it indicates that the company managing the fund is either charging high fees or not properly tracking the index.
There are two ways of calculating NAL. Keep reading to review the detailed steps of both processes:
Determining Purchase Cost
- Note the financial data related to the purchase including depreciation, cost, usable duration, repayments, tax rate, cost of maintenance, and the estimated value at the end of its useful life.
- Create a table to learn the cost of purchasing the car. Also mention the number of years you’ll be using this vehicle.
- Fill in all other related figures. Don’t forget to add the minus sign before cash outflows.
- Create a horizontal line below the final cash flow items. Add all the cash flow items for the entire year to obtain the total cash flow.
- Obtain the net present value of the cash flow.
Determining Lease Cost
- Note all the data related to the leasing cost as well as the lease term and payment per month.
- Create a table for the lease cost noting the time period across the columns as well as the cash flow items in the rows.
- Fill in the cash flow items and mark a minus sign for cash outflow.
- In the end, make a horizontal line and add the cash flow for the year.
- Determine the net present value of the cash flow for the entire leasing period.
Deduct the purchase cost from the leasing cost and you will get the NAL.
When companies or individuals have to face the situation of whether to lease or purchase assets like a car or other vehicle, NAL helps determine the appropriate decision. By taking into account all the associated costs and calculating the net present value, the prospective user can determine whether one option makes more financial sense than the other with a few relevant numbers.