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Effective Income represents the lease savings the owner does not pay by purchasing the building.
Cash Flow Before Tax represents the down payment, actual savings after debt , and the proceeds from sale the owner receives by purchasing the building.
This creates a "T-bar", and allows an IRR calculation on the down payment. In this case the owner will receive savings worth 19.7% IRR Before Tax on a $232,000 down payment.
If the owner cannot make 19.7% IRR Before Tax in another investment, then purchasing the property will give the greatest return on investment. Hence all things being equal, the purchase of the property would be the logical choice.
If the owner can make more than 19.7% IRR Before Tax in another investment, then purchasing the property would not give the greatest return on investment. Hence all things being equal, leasing the property would be the logical choice.
If the owner makes 19.7% IRR Before Tax in another investment, then 19.7% IRR Before Tax is the point of indifference, when buying or lease yields the same investment opportunities. Hence all things being equal, the leasing or purchase of the property would both be equally logical.
Time |
Investment and Sale |
Effective Income |
Operating Expense |
Cash Flow Before Debt |
Debt Service |
Cash Flow Before Tax |
| Buy | (1,020,000) | 0 | 0 | (1,020,000) | 788,000 | (232,000) |
| 2001 | 0 | 93,000 | 0 | 93,000 | (87,815) | 5,185 |
| 2002 | 0 | 97,650 | 0 | 97,650 | (87,815) | 9,835 |
| 2003 | 0 | 102,533 | 0 | 102,533 | (87,815) | 14,717 |
| 2004 | 0 | 107,659 | 0 | 107,659 | (87,815) | 19,844 |
| 2005 | 0 | 113,042 | 0 | 113,042 | (87,815) | 25,227 |
| 2006 | 0 | 118,694 | 0 | 118,694 | (87,815) | 30,879 |
| 2007 | 0 | 124,629 | 0 | 124,629 | (87,815) | 36,814 |
| 2008 | 0 | 130,860 | 0 | 130,860 | (87,815) | 43,045 |
| 2009 | 0 | 137,403 | 0 | 137,403 | (87,815) | 49,588 |
| 2010 | 0 | 144,274 | 0 | 144,274 | (87,815) | 56,458 |
| Sell | 1,531,161 | 0 | 0 | 1,531,161 | (732,978) | 798,184 |
| Total | 511,161 | 1,169,744 | 0 | 1,680,905 | (823,128) | 857,777 |
| Rate of Return Before Debt (IRR) | 14.3% |
| Rate of Return Before Tax (IRR) | 19.7% |
| Net Present Value Before Debt @12% | 141,615 |
| Net Present Value Before Tax @12% | 168,514 |
Time |
Taxable Revenue |
Taxable Expense |
Interest Expense |
Depre- ciation |
Ordinary Income |
| Buy | 0 | 0 | 0 | 0 | 0 |
| 2001 | 93,000 | 0 | (84,211) | (18,429) | (9,640) |
| 2002 | 97,650 | 0 | (83,770) | (19,231) | (5,350) |
| 2003 | 102,533 | 0 | (83,280) | (19,231) | 22 |
| 2004 | 107,659 | 0 | (82,736) | (19,231) | 5,692 |
| 2005 | 113,042 | 0 | (82,132) | (19,231) | 11,679 |
| 2006 | 118,694 | 0 | (81,462) | (19,231) | 18,002 |
| 2007 | 124,629 | 0 | (80,717) | (19,231) | 24,681 |
| 2008 | 130,860 | 0 | (79,891) | (19,231) | 31,738 |
| 2009 | 137,403 | 0 | (78,974) | (19,231) | 39,199 |
| 2010 | 144,274 | 0 | (77,955) | (18,429) | 47,889 |
| Sell | 0 | 0 | (8,000) | 0 | (8,000) |
| Total | 1,169,744 | 0 | (823,128) | (190,705) | 155,911 |
The after tax point of indifference is 15.9% IRR After Tax.
If you make 10% IRR after tax on other investments, all things being equal what would be the logical choice here? Leasing or Purchasing?
Answer: Purchasing, because the other investment returns 10% after tax on the $232,000 investment, and the purchase returns 15.9% in after tax savings.
Time |
Cash Flow Before Tax |
Ordinary Income |
Capital Gains |
Taxable Income |
Taxes |
Cash Flow After Tax |
| Buy | (232,000) | 0 | 0 | 0 | 0 | (232,000) |
| 2001 | 5,185 | (9,640) | 0 | (9,640) | 3,278 | 8,463 |
| 2002 | 9,835 | (5,350) | 0 | (5,350) | 1,819 | 11,654 |
| 2003 | 14,717 | 22 | 0 | 22 | (7) | 14,710 |
| 2004 | 19,844 | 5,692 | 0 | 5,692 | (1,935) | 17,909 |
| 2005 | 25,227 | 11,679 | 0 | 11,679 | (3,971) | 21,256 |
| 2006 | 30,879 | 18,002 | 0 | 18,002 | (6,121) | 24,759 |
| 2007 | 36,814 | 24,681 | 0 | 24,681 | (8,391) | 28,422 |
| 2008 | 43,045 | 31,738 | 0 | 31,738 | (10,791) | 32,254 |
| 2009 | 49,588 | 39,199 | 0 | 39,199 | (13,328) | 36,261 |
| 2010 | 56,458 | 47,889 | 0 | 47,889 | (16,282) | 40,176 |
| Sell | 798,184 | (8,000) | 701,866 | 693,866 | (235,915) | 562,269 |
| Total | 857,777 | 155,911 | 701,866 | 857,777 | (291,644) | 566,133 |
| Rate of Return Before Tax (IRR) | 19.7% |
| Rate of Return After Tax (IRR) | 15.9% |
| Net Present Value Before Tax @12% | 168,514 |
| Net Present Value After Tax @12% | 70,950 |