J.2 COST OF LEASING

Leasing equipment is an alternative to purchasing. Because the lessee is obligated to make a series of payments, a lease arrangement resembles a debt contract. Thus, the cost advantages cited for leasing are often based on a comparison between leasing and purchasing using borrowed funds on an intermediate-term (maturity between 3 and 10 years) or long-term (maturity greater than 10 years) basis.

In a perfect capital market where transactions can be arranged costlessly, leasing (like any other financial intermediation function) would not in itself create economic value. For the lessee firm could costlessly arrange, on its own account, the same transactions as the lessor. However, as soon as transactions costs and the need for the lessor to earn a market rate of return on invested capital are admitted, it would appear that the firm using leasing transactions would be paying at least as much to the leasing firm as it would cost the firm to arrange the financing itself.