Cromack Industries - Lease Value Calculator

# Background

The Lease Value Calculator is used when the owner of a lease, with a multi-year revenue stream, wishes to sell the revenues for a one-time payment.  The procedure for finding the value of such a lease is based on some financial analysis techniques used to find the present value of annuities.  Annuities are simply financial instruments that consist of a “series” of cash flows.  There is, however, one caveat.  The “value” of a lease is not an absolute quantity, but rather it is relative to other investment opportunities that the seller may have.

# Inputs for the Calculations

The "Operating Cash Flow" is the annual lease income AFTER deducting operating costs associated with the lease. Examples of typical operating costs are land taxes and utilities.

Many tower site (and other real estate) leases contain escalator clauses that increase the lease payment by a fixed percentage each year. If this is the case then enter the annual percentage, otherwise enter "0".

The Discount Rate is the rate of return one can expect to get if the one-time payment is reinvested or an existing liability (such as a business loan or a mortgage) is retired. One should be conservative in choosing the Discount Rate because the higher this rate is, the lower the present value of the annuity is.  However, one should not be arbitrary either in choosing the discount rate.  Typically, in Lease Value problems, one sets the discount rate to one’s cost of capital.

# The Program Outputs

This program computes two values for an annuity with, or without, annual payment growth.  The Net Present Value (NPV) of the annuity is the sum of “all” future cash flows, each discounted to the their present value.  The program can compute the NPV of both an “Annuity Due” and an “Ordinary Annuity”.  With an Ordinary Annuity payments are made at the end of each period while with an Annuity Due payments are made at the beginning of each period.  Lease payments are typically due at the beginning of each period, so use the Annuity Due option here.  Mortgage payments, on the other hand, are due at the end or each period, so Ordinary Annuity calculations apply in this case.

The program also computes the Face Value and the Cash Value.  The Face Value is simply the sum of all cash flows (a.k.a. payments) over the life of the financial instrument.  The Cash Value of the annuity is the amount of the one-time payment that, when invested with a return equal to the specified discount rate, compounds in value to the Face Value of the annuity.

# So, What is the Value of My Lease?

The answer depends on how the proceeds are going to be used.  Do I use NPV or Cash Value?

Implicit in the NPV concept is the notion that “payments” are still going to be made – in one form or another.  Say you plug in some numbers and compute the NPV of your lease (which is “N” years long).  The value you compute is not static, but rather is based on the assumption that you will withdraw the “payment” amount for another N years while compounding the balance at the discount rate.  At the end of another N years you will have zero dollars.  Therefore, if you are going to use the proceeds to pay off a mortgage, for example, then the NPV is the correct analysis tool to use.

The Cash Value, on the other hand, is a static value.  Here it is assumed that the proceeds will be invested at the discount rate, but the investment will not be otherwise disturbed.  It is presented here for both comparison and completeness.

If the price a prospective buyer offers you seems too low, ask that buyer what discount rate their lease value is based on.  That being said, you should always compute “your own” lease value based on a discount rate that represents an investment rate of return you can “actually” obtain.

By: Gary T. Cromack, MBA, MSEE

President & CFO

Cromack Industries, Inc. and Trans-Site Corporation

Revised July 24, 2010