How lease vs buy costs are calculated
The lease versus buy decision is a capital budgeting problem that requires comparing two cash flow streams on a like-for-like basis. The naive comparison — total lease payments versus purchase price — is almost always misleading because it ignores the time value of money, the tax deductibility of different payment types, the financing cost of buying, the residual value of owned equipment, and the different maintenance obligations under each option.
A proper comparison calculates the net present value of after-tax cash flows for each option over the same period. Cash flows are discounted at the company's cost of capital (WACC or discount rate) so that a dollar paid in year 3 is worth less than a dollar paid today. Lease payments are typically fully deductible as operating expenses for tax purposes. When buying, only the interest component of loan payments is deductible (not the principal repayment), but the asset can be depreciated to generate a tax shield over its useful life.
The key formulas
Monthly loan payment = P × [r(1+r)^n] / [(1+r)^n − 1]
where P = amount financed, r = monthly rate, n = term in months
After-tax lease cost per year = annual lease payments × (1 − tax rate)
After-tax interest cost (buy) = annual interest × (1 − tax rate)
Annual depreciation tax shield = (depreciation ÷ useful life) × tax rate
Net buy cost = down payment + total loan payments + maintenance − residual value − tax savings
Net lease cost = total payments + deposit + maintenance − tax savings
NPV = ∑ [cash flow_t ÷ (1 + discount rate)^t], t = 1 to n
The discount rate should reflect the after-tax cost of borrowing or the company weighted average cost of capital (WACC). Using the pre-tax loan rate overstates the cost of capital. Declining balance depreciation at 2x applies twice the straight-line rate to the declining book value each year.
Tax treatment comparison
| Cost component | Lease tax treatment | Buy tax treatment | Advantage |
|---|
| Monthly payments / principal | Fully deductible (operating expense) | Not deductible | Lease |
| Interest component | Included in deductible payment | Deductible separately | Neutral |
| Depreciation | No benefit (lessor claims it) | Tax shield on depreciation | Buy |
| Residual value | No benefit (return to lessor) | Recovered on sale | Buy |
| Balance sheet | Operating lease: off B/S | Asset + liability on B/S | Lease |
When each option typically wins
Leasing wins most often when: the lease rate is competitive, the tax rate is high (making full payment deductibility valuable), the equipment depreciates rapidly (lowering the residual value advantage of ownership), and the discount rate is high (reducing the NPV of future ownership benefits). Buying wins most often when: the interest rate is low, the equipment retains significant residual value, the business can claim accelerated depreciation (boosting the tax shield), and the equipment will be used beyond the lease term. When the numbers are close — within 5% to 10% of each other — qualitative factors (flexibility, cash flow, balance sheet preference, upgrade cycles) should dominate the decision.
Worked examples
Example 1: Commercial vehicle, leasing wins
Equipment: $60,000 vehicle. Buy: $12,000 down payment, 5-year loan at 8%, maintenance $2,500/year, residual value $8,000. Lease: $1,100/month for 5 years, $2,000 deposit, maintenance $800/year. Tax rate 25%, discount rate 8%. Lease wins by approximately $4,200 net after tax, driven by the full deductibility of lease payments and lower maintenance obligation under the lease contract.
Example 2: Manufacturing machinery, buying wins
Equipment: $200,000 CNC machine. Buy: $40,000 down, 7-year loan at 6.5%, maintenance $5,000/year, residual value $40,000. Lease: $3,200/month for 7 years, $10,000 deposit, maintenance $2,000/year. Tax rate 30%, discount rate 7%. Buying wins by approximately $22,000 due to the strong residual value ($40,000 recovered at end) and significant depreciation tax shield on a long-lived, high-value asset.
| Scenario | Asset value | Lease total (after tax) | Buy total (after tax) | Winner | Saving |
|---|
| Commercial vehicle | $60,000 | $53,400 | $57,600 | Lease | $4,200 |
| CNC machinery | $200,000 | $178,200 | $156,400 | Buy | $21,800 |
| Office tech (5 yr) | $25,000 | $18,600 | $19,100 | Lease | $500 |
| Heavy plant (10 yr) | $500,000 | $412,000 | $375,000 | Buy | $37,000 |
Frequently Asked Questions
Why does the calculator use after-tax costs rather than gross costs?+
Using gross (pre-tax) costs overstates the true burden of both options and produces incorrect comparisons. Lease payments are typically deductible as operating expenses, meaning a $1,200/month lease payment at a 25% tax rate only costs $900/month after tax. For the buy option, only the interest component of loan payments is deductible (principal repayment is not), but depreciation generates a separate tax shield. Since the two options have different tax profiles, comparing them on a gross basis gives a misleading result. The after-tax cost is the correct basis because it represents the actual cash that leaves the business net of the tax benefit received.
What is the NPV comparison and why does it matter?+
NPV (Net Present Value) discounts all future cash flows to their present value using the company's discount rate. This is necessary because $10,000 paid today is worth more than $10,000 paid in year 5. When comparing lease versus buy, the timing of cash flows differs: lease payments are spread evenly over the term, while buying involves a large down payment upfront and potentially a residual value received at the end. Without discounting, you cannot meaningfully compare these different timing profiles. The NPV comparison is the most financially rigorous way to evaluate the two options and is the method used in corporate capital budgeting.
How does depreciation create a tax benefit when buying?+
When you buy an asset, you cannot deduct the full purchase price immediately (in most jurisdictions). Instead, you depreciate it over its useful life, taking a deduction each year. Each year's depreciation deduction reduces taxable income, creating a tax saving equal to the depreciation amount times the tax rate. For example, a $100,000 asset depreciated straight-line over 5 years gives $20,000/year in depreciation. At a 25% tax rate, this saves $5,000/year in tax, totalling $25,000 over 5 years. Accelerated depreciation methods (declining balance, Section 179 in the US) allow larger deductions in early years, increasing the present value of the tax shield and making buying more attractive.
Does leasing affect the balance sheet differently from buying?+
Under IFRS 16 and ASC 842 (introduced in 2019), most leases must now be recognised on the balance sheet as a right-of-use asset and lease liability, regardless of whether they are operating or finance leases. This largely eliminated the traditional off-balance-sheet advantage of operating leases for large companies. However, IFRS 16 and ASC 842 include exemptions for short-term leases (under 12 months) and low-value assets (typically under $5,000), which many SME equipment leases still qualify for. If your lease qualifies for an exemption, it can still remain off-balance-sheet. For covenant-sensitive businesses, this distinction matters for leverage ratios and EBITDA adjustments.
What should I do if the numbers are very close?+
When the financial advantage is within 5% to 10% of total cost, qualitative factors should dominate the decision. Consider: how certain is your equipment usage beyond the lease term (if uncertain, leasing gives more flexibility to upgrade or return); how important is cash flow preservation (leasing often requires less upfront capital); how rapidly does this type of equipment become obsolete (tech equipment favours leasing, heavy plant favours buying); whether your loan covenants or credit ratios are affected by on-balance-sheet debt (leasing may help); and whether the equipment can be customised to your needs (owned assets can be modified, leased assets usually cannot). Tax advice specific to your jurisdiction is also important since depreciation rules vary significantly by country and can swing the decision.
How do I handle equipment that I will use beyond the lease term?+
If you plan to use equipment for longer than the lease term, the comparison must include what happens at lease end. You have three options: return the equipment and re-lease (at then-current rates, which may be higher), purchase the equipment at the residual value specified in the lease, or negotiate a lease extension. This calculator models the end-of-lease option as either return, purchase at residual value, or renewal. If you plan to own the equipment long-term, buying is usually more cost-effective than repeatedly re-leasing, particularly for assets with low obsolescence risk. Set the comparison period to your true intended usage period and model the end-of-lease purchase option for the fairest comparison.