Explanation

The issues in a lease analysis are:

The estimated residual value of the asset fluctuates due to inflation or any other market forces. High competition decreases the leasing rates upto the point where residual values are completely recognised in the lease contract.
A lessee might choose purchasing the equipment over leasing as investment made to purchase the equipment will benefit the lessee in availing investment tax credit. The investment tax credit is the deduction of a certain percentage of investment cost from taxes of the firm. However, the tax differentials between the lessee and the lessor makes leasing attractive.
A lease agreement with a cancellation clause enhances the lessor’s risk as the lessee can cancel the lease anytime during the agreement, high risk is adjusted in the discounting rate and that in turn, reflects lower present value of residual cash flows.

Verified Answer

The issues in a lease analysis are:

The higher residual value of the asset makes a lease less attractive.
An investment tax credit makes the lessee to choose owning the equipment over leasing it. However, the tax differentials between the lessee and the lessor makes leasing attractive.
The inclusion of cancellation clause in the lease agreement enhances the risk of lessor.

Apart from the numerical evaluation which indicates owning the asset is more attractive than leasing, the leasing will still be beneficial due to lower risks, estimated project life, maintenance costs, The leasing also mitigates the risks for the lessor as the risks are reduced due to portfolio risk investment.