Unformatted text preview: imple tax adjustment of the annual
lease payments. In addition, the cost of exercising a purchase option in
the final year of the lease term must frequently be included.1
1. Including the cost of exercising a purchase option in the cash flows for the lease alternative ensures that under
both lease and purchase alternatives the firm owns the asset at the end of the relevant time horizon. The other
approach would be to include the cash flows from sale of the asset in the cash flows for the purchase alternative at
the end of the lease term. These strategies guarantee avoidance of unequal lives, which were discussed in Chapter 10.
In addition, they make any subsequent cash flows irrelevant because these would be either identical or nonexistent,
respectively, under each alternative. CHAPTER 16 Hybrid and Derivative Securities 677 Step 2 Find the after-tax cash outflows for each year under the purchase alternative. This step involves adjusting the sum of the scheduled loan
payment and maintenance cost outlay for the tax shields resulting from
the tax deductions attributab...
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