Wednesday, May 03, 2006

Discount Rate for evaluating lease vs buy decision

When a company is evaluating the lease vs buy option, the discount rate normally used to discount the cashflows is the rate at which the company is able to borrow i.e. if the company is able to borrow funds from the bank at 5%, it will discount the cashflows at 5%.

However if the company has accepted maximising EVA as its goal, should it not discount the cashflows at the Weighted Average Cost Of Capital (WACC) rather than the borrowing rate? Assuming the WACC for the company is 15%, it will maximise it's EVA, if it cashflows from both the options are discounted at 15% rather than 5%.

Can anybody help me in this regard?